TRI Pension Services/ Archives of Old "What's New" Summaries (Prior to July 1, 2001)

The summaries below previously appeared on the "What's New/Current Developments" page of our website (before July 1, 2001). Each item includes the date it was originally posted. We provide these items for reference purposes. The items are organized in reverse chronological order (i.e., starting with the summaries posted last within this time period). Please note that some of the items may have been modified by subsequent guidance issued by Congress, one the governmental agencies, or a court. For the more recent current developments, go to the What's New/Current Developments page.

IRS provides pre-2001 relief from requirement to include in section 415 compensation salary reduction contributions that are used to purchase qualified transportation fringe benefits (added June 4, 2001; modified June 9, 2001). In a story on March 3, 2001 (see below on this What's New page), we reported on The Consolidated Appropriations Act, 2001 (Public Law 106-554), which included an amendment to the definition of compensation under IRC §415. (Note that in Notice 2001-37, the IRS refers to this Act as the Community Renewal Tax Relief Act of 2000.) As amended, IRC §415(c)(3)(D) now includes salary reduction contributions to purchase qualified transportation fringe benefits, as described in IRC §132(f)(4), in the definition of compensation used to compute the §415 limits (i.e., the 25%-of-compensation annual additions limit for defined contribution plans in pre-2002 limitation years, and the 100%-of-compensation annual additions limit in post-2001 limitation years, because of amendments made by the Economic Growth and Tax Relief Reconciliation Act of 2001).

IRS addresses the retroactive effective date problem. This change to §415(c)(3)(D) was retroactive to years beginning after December 31, 1997, which is the same year that the inclusion of elective deferrals under cafeteria plans was included in the definition of §415 compensation. This means that for years beginning in 1998, 1999, and 2000, plans may have administered the §415 limits incorrectly, as well as other tax code provisions that rely on the §415 compensation definition (e.g., compensation requirement for highly compensated employee testing). In Notice 2001-37, the IRS provides transition relief. For plan years beginning prior to January 1, 2001, the plan will be treated as satisfying the section 415 definition of compensation, even if the plan did not "gross up" for salary reduction contributions used to purchase qualified transportation benefits, as described in IRC §132(f)(4), and any calculations under the plan that would have been affected do not have to be adjusted to take into account such contributions. However, the plan must start "grossing up" for these contributions for plan years beginning after December 31, 2000. A conforming amendment to the plan must be adopted by the end of the GUST remedial amendment period. If the plan in fact grossed up for the IRC §132(f)(4) contributions in a plan year beginning after December 31, 1997, but before January 1, 2001, the GUST amendment also must reflect the earlier effective under the operation of the plan.

• Example. A company offers qualified transportation fringe benefits that employees may purchase through a salary reduction agreement, pursuant to IRC §132(f)(4) ("132(f)(4) contributions"). For the plan year beginning January 1, 1998, an employee reduced her salary by $1,000, to purchase these benefits. In addition, she contributed $3,000 to the company's 401(k) plan and $2,000 to the company's cafeteria plan. Her "net" compensation (after all of these subtractions) was $53,000. When the plan administrator calculated her IRC §415 limitation, it treated her compensation as $58,000 (i.e., her $53,000 net compensation, plus the $3,000 contribution to the 401(k) plan and the $2,000 contribution to the cafeteria plan). The administrator did not include the $1,000 of 132(f)(4) contributions. Thus, the plan determined that the employee's IRC §415 limit was 25% times $58,000, or $14,500. Technically, the plan was supposed to include the $1,000 for the §132(f)(4) contribution, which would have made this employee's section 415 compensation $59,000, and the 25% limit $14,750. The plan followed this approach for all other participants who made salary reduction contributions for qualified transportation fringe benefits, and did the same for the plan year beginning January 1, 1999, and the plan year beginning January 1, 2000. The plan does not have to apply the gross-up for the 132(f)(4) contributions for the 1998, 1999 and 2000 plan years, even though the law change was technically retroactive to such years, because Notice 2001-37 provides relief. If this employee's allocation was reduced in the 1998 plan year, because the §415 limit was assumed to be $14,500, rather than $14,750, the plan does not have to make up an allocation to the employee. However, starting with the plan year beginning January 1, 2001, the plan must "gross up" for 132(f)(4) contributions. An amendment reflecting the new rule must be adopted during the GUST remedial amendment period and must be effective as of January 1, 2001.
• Example. Suppose in the prior example, that the plan administrator thought section 415 compensation included the §132(f)(4) contribution, because it was similar to a cafeteria plan contribution. Thus, the administrator calculated the employee's section 415 compensation as $59,000, rather than $58,000. The administrator continued to administer the plan this way for 1999 and 2000. In this case, it turns out the administrator ended up anticipating the law change made by the Consolidated Appropriations Act of 2001 without realizing it. When the amendment is adopted to reflect the inclusion of §132(f)(4) contributions, the amendment is retroactive to January 1, 1998, because that is when the plan started complying in operation with this rule.
• Model amendment. A model amendment is provided in an appendix to Notice 2001-37 that may be used to conform the plan to this law change. The model amendment may be adopted now or as part of the employer's GUST amendments. A sponsoring organization of a master/prototype plan (M&P plan) also may adopt the model amendment on behalf of its adopting employers. If an M&P plan sponsor adopts the model amendment, it must file Form 8837 with the IRS.

Pension reform is a reality - contribution limits significantly increased, some helpful simplification to top heavy and certain nondiscrimination testing rules, some delayed phase-ins in Senate bill accelerated in final legislation (added May 28, 2001; modified May 30, 2001). The Economic Growth and Tax Relief Reconciliation Act of 2001 (H.R. 1836) (EGTRRA 2001) passed both houses of Congress on May 26, 2001. The vote was 240 to 154 in the House, and 58 to 33 in the Senate. President Bush is expected to sign the legislation. The pension provisions originally had been part of H.R. 10 and S. 896, but were incorporated into the tax cut bill negotiated through both houses of Congress in a whirlwind legislative session ending on Saturday morning, May 26, 2001, squeaking through before Congress adjourned for its Memorial Day recess. TRI Pension Services will provide a complete explanation of the pension provisions in the EGTRRA in the Summer 2001 issue of ERISA Views (to be published in July 2001). Here is a brief run-down of the most significant pension provisions.

• Increased dollar limits. Section 611 of the new law increases the following plan limits: 1) the elective deferral limit for 401(k) plans, 403(b) plans, and 457 plans is $11,000 in 2002, $12,000 in 2003, $13,000 in 2004, $14,000 in 2005, and $15,000 in 2006, with cost-of-living increases (in $500 multiples) thereafter, 2) the dollar limit under §415(c)(1)(A) (pertaining to annual additions under defined contribution plans) is $40,000 for 2002, with cost-of-living increases (in $1,000 multiples) thereafter, 3) the dollar limit under §415(b)(1)(A) (pertaining to the annual benefit payable under defined benefit plans) is $160,000 for 2002, with cost-of-living increases (in $5,000 multiples) thereafter, 4) the compensation dollar limit under IRC §401(a)(17) is $200,000 for 2002, with cost-of-living increases (in $5,000 multiples) thereafter, and 5) the elective deferral limit for SIMPLE-IRAs and SIMPLE 401(k) plans is $7,000 for 2002, $8,000 for 2003, $9,000 for 2004, and $10,000 for 2005, with cost-of-living adjustments (in $500 multiples) thereafter. Also, under section 615 of the new law, individuals who are eligible under a 457 plan do not have to coordinate the contribution limit under the 457 plan with the contribution limit under IRC §402(g) (pertaining to elective deferrals under 401(k) and 403(b) plans), starting in 2002.
• Increased deduction limits for employers. Deduction limits for profit sharing plans and stock bonus plans are significantly increased through a combination of three changes (see sections 614 and 616 of the new law): 1) the 15% limit under IRC §404(a)(3) is increased to 25% of aggregated participant compensation, 2) 401(k) deferrals are separately deductible with regard to the 25% limit and do not "eat away" the 25% limit applicable to other employer contributions (e.g., matching contributions, nonelective contributions), and 3) participant compensation used to calculate the 25% limit described in 1) is based on section 415 compensation, which means it is "grossed up" for elective deferrals made by participants under 401(k) plans, cafeteria plans, etc. For example, suppose the aggregate compensation of all participants in a 401(k) plan is $1,000,000 (before compensation is reduced for elective deferrals), and the participants defer a total of $50,000 under the 401(k) arrangement. Further suppose the employer matches those deferrals 100% and makes a profit sharing contribution in the amount of $200,000. The entire $300,000 (i.e., $50,000 401(k) deferrals, $50,000 matching contributions, and $200,000 profit sharing contributions) is fully deductible. The 25% deduction limit is $250,000 (i.e., 25% x $1,000,000), which supports the deduction for the matching contributions and profit sharing contributions. The $50,000 of 401(k) contributions are also fully deductible, without regard to the 25% limit, and do not reduce the $250,000 deduction limit applicable to the matching contributions and profit sharing contributions. These changes take effect for employers' taxable years that begin in 2002 and later. Since the deduction limit under §404(a)(3) has been increased to 25%, the law also subjects money purchase plans to this deduction limit (rather than the deduction limit under §404(a)(1)) for post-2001 taxable years of the employer. Thus, the pension plan deduction rules under §404(a)(1) will apply only to defined benefit plans. However, the Treasury has authority to create exceptions to the 25% limit for money purchase plans (e.g., to address contributions made to satisfy funding deficiencies that might otherwise cause the 25% limit to be exceeded). The deduction limit increases described in this paragraph should eliminate the need for money purchase plans in most situations.
• Catch-up contributions for individuals age 50 and older. Starting in the year in which an individual reaches age 50 and subsequent years, a plan may allow the individual to make a "catch-up" contribution. See section 631 of the new law. The catch-up contribution rule may be provided under a qualified plan, a 403(b) plan, a 457 plan maintained by a governmental entity, a SIMPLE-IRA plan or a SIMPLE-401(k) plan. The maximum catch-up contribution for qualified plans, 403(b) plans, and 457 plans is $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006. The maximum catch-up contributions for SIMPLE-IRAs and SIMPLE-401(k) plans is $500 in 2002, $1,000 in 2003, $1,500 in 2004, $2,000 in 2005, and $2,500 in 2006. The 2006 limit is subject to cost-of-living adjustments (in $500 multiples) starting in 2007. The catch-up contribution does not count against the IRC §402(g) limit (pertaining to maximum elective deferrals under 401(k) and 403(b) plans), the IRC §415 limit (as increased by the provisions of this new law), the IRC §457(b) limit, the SIMPLE limits under IRC §408(p) and IRC §401(k)(11), the SEP limits under IRC §402(h), the deduction limit under §404, nor the plan's limit on elective deferrals (e.g., if a 401(k) plan's normal limit on elective deferrals is 10% of compensation, the catch-up contribution would be in addition to the maximum deferrals permitted under the plan's normal limit). The right under a qualified plan to make catch-up contributions must be available on a nondiscriminatory basis to eligible participants (e.g., the plan could not allow only highly compensated employees who are over age 50 to make catch-up contributions). Catch-up contributions will not cause a plan to fail the ADP and ACP tests under 401(k) plans, the 401(a)(4) nondiscrimination test on the amount of contributions or benefits provided by the employer, or the coverage tests under IRC §410(b). The Treasury will have to prescribe operating rules on how to run the applicable nondiscrimination tests where an employees has made catch-up contributions (or contributions that can be potentially characterized as catch-up contributions). Catch-up contributions are allowed starting in 2002.
• Elimination of 25% annual additions limit for defined contribution plans; elimination of maximum exclusion allowance for 403(b) plans. Section 632 of the new law significantly increases contribution limits for middle-income and lower-income participants. The annual additions limit under §415(c)(1)(A) is increased from 25% to 100% of compensation. Thus, for 2002, the annual additions limit is 100% of compensation for participants who earn less than $40,000, and the limit is $40,000 for participants who earn $40,000 or more. This should eliminate violations of the §415 limit for participants who defer significant percentages of their income through the 401(k) arrangement. For example, suppose a participant under a 401(k) plan earns $35,000 a year and is married to an individual whose employer does not offer a 401(k) arrangement. The couple decides to have the participant in the 401(k) defer $11,000 for 2002 (i.e., the elective deferral limit for 2002, as increased by the new law). The annual additions limit for this employee is $35,000 (i.e., 100% of compensation, determined prior to the 401(k) deferral), so an additional $24,000 could still be allocated to this participant (e.g., matching contributions, employer nonelective contributions). Under old law, this participant's 415 limit was 25% x $35,000, or $8,750, and the participant's 401(k) deferrals had to be less than that amount if there were other annual additions allocated, such as matching contributions. Corresponding amendments are made to 403(b) plan limits and 457 plan limits. For 403(b) plans, the maximum exclusion allowance under IRC §403(b)(2) is repealed, effective January 1, 2002, substituting the §415 limit. For 457 plans, the 33-1/3% limit under prior law is replaced by a 100% of compensation limit, to coordinate with the §415 limit that is applicable to qualified plans and 403(b) plans.
• Higher benefit limits for early retirement. Under section 611 of the new law, the dollar limit under IRC §415(b)(1)(A) (pertaining to defined benefit plans) is applicable to benefits that commence between the ages of 62 and 65, starting in limitation years that end in 2002 or later. (Current law links the dollar limit to benefits commencing at social security retirement age.) A reduction to the dollar limit will apply only to benefit commencement before age 62 (rather than before social security retirement age) and the increase in the dollar limit will apply to benefit commencement after age 65 (rather than after social security retirement age). If you are having a deja vu experience right now, there is a reason for that. This is the way the law stood before the Tax Reform Act of 1986. Significantly higher benefits will be available for those retiring in their 50s and 60s, hopefully making defined benefit plans more attractive retirement vehicles, particularly for small employers.
• Portability of benefits among all employer-sponsored retirement plans; rollovers of pre-tax IRA distributions to employer-sponsored plans; trustee-to-trustee transfers of after-tax contributions. Sections 641, 642 and 643 of the new law significantly expands the portability of benefits: 1) distributions from qualified plans, 403(b) plans, and governmental 457 plans may be rolled into any of such plans, or into IRAs (e.g., a qualified plan distribution could be rolled over into a 403(b) custodial account, or vice versa), 2) pre-tax distributions from IRAs (i.e., distributions from traditional IRAs that are not treated as a return of basis under the IRC §72 rules) are eligible for rollover into qualified plans, 403(b) plans, or 457 plans, and 3) after-tax employee contributions under a qualified plan are eligible for a direct trustee-to-trustee transfer to another qualified plan or to an IRA. Conforming amendments are made to IRC §402(f), which requires notice of rollover rights, so that 403(b) plans and governmental 457 plans are subject to the notice requirement, and distributions from a governmental 457 plan, that are attributable to rollovers from qualified plans or 403(b) plans to the 457 plan, remain subject to the premature distribution penalty rules under IRC §72(t). Section 644 of the new law also gives Treasury the authority to extend the 60-day rollover period for reasonable circumstances. Finally, section 645 expands the elective transfer exception under IRC §411(d)(6) so that optional forms of benefit may be voluntarily waived by an employee through an elective transfer transaction, so long as the transferee plan includes a single sum payment option.
• Automatic rollovers for involuntary distributions. If a plan makes an involuntary distribution of more than $1,000, and the employee does not affirmatively elect to receive cash or to make a direct rollover, the default method of payment must be a direct rollover to an IRA. See section 657 of the new law, which amends IRC §401(a)(31). The Secretary of Labor must issue regulations that will prescribe safe harbors with respect to investments in the default IRA, so that the plan administrator will be relieved of fiduciary liability with respect to such rollover. This default rollover rule does not take effect until the Secretary of Labor issues those regulations.
• Changes to top heavy rules. Section 613 of the new law makes some significant changes to the top heavy rules: 1) the 5-year testing period for determining key employees is modified to a 1-year testing period (i.e., the data for the four prior years are irrelevant), 2) the compensation requirement for the officer test (pertaining to the identification of key employees) is increased to $130,000 (subject to cost-of-living adjustments, in $5,000 multiples, starting in 2003, 3) the top ten owner test is eliminated from the definition of key employee, 4) matching contributions will count toward satisfying the employer's top heavy minimum contribution liability and are still counted in the ACP nondiscrimination test, 5) a 1-year lookback, rather than a 5-year lookback, applies for adding back distributions made after a separation from service or termination of the plan, when determining whether a plan is top heavy, 6) safe harbor 401(k) plans that offer a matching contribution that satisfies the requirements of IRC §401(m)(11) are exempt from the top heavy rules, and 7) top heavy minimum accruals are not required under a defined benefit plan for any plan year that no key employee or former key employer benefits under the plan (using the coverage testing rules to determine whether an employee benefits). These rules take effect for top heavy determinations and key employee determinations for plan years beginning in 2002 or later.
• Multiple use test repealed in 2002. The multiple use test under IRC §401(m)(9) is repealed for plan years beginning in 2002 and later. See section 666 of the new law. Due to this repeal, the full "2% spread" may be used in both the ADP test and the ACP test.
• Faster vesting for matching contributions under non-top-heavy plans. A plan that is not top heavy must apply the top heavy vesting schedules for matching contributions that are made in plan years that begin in 2002 or later. See section 633 of the new law. The top heavy schedules require 100% vesting after a participant has three years of service (known as "3-year cliff vesting") or 100% vesting after six years of service, provided that the participant's vesting percentage is no less than 20% after two years of service, 40% after three years of service, 60% after four years of service, and 80% after five years of service (sometimes known as "6-year graded vesting"). The accelerated vesting rule only need apply to a participant who has at least one hour of service credited after the effective date of this new rule. Top heavy plans are not affected because they already apply the top heavy vesting schedules to matching contributions.
• Uniform loan rules for all business owners. Section 612 of the new law eliminates the current prohibition on making plan loans to certain participants who are owners of an unincorporated employer (e.g., sole proprietorship, partnership, LLC) or S corporation. These individuals may receive loans from the plan, without engaging in a prohibited transaction, for year beginning after December 31, 2001.
• Tax credits for certain contributions and plan-related expenses. The new law adds some new tax credits for certain contributions and plan-related expenses. The credits are nonrefundable, meaning that an individual (or eligible employer) cannot generate an income tax refund with respect to such credits. Section 618 of the new law adds new IRC §25B, which allows individuals who meet certain adjusted gross income (AGI) limits to claim an income tax credit. The credit may pertain to 401(k) contributions, 403(b) contributions, 457(b) contributions (if the employer is a government), and voluntary after-tax employee contributions. The maximum amount of contributions eligible for the credit is $2,000 per year, and the credit equals a specified percentage (not exceeding 50%) of such contributions, based on the individual's AGI. The credit is first available for contributions made in 2002, and expires December 31, 2006. Section 619 of the new law adds IRC §45E, which allows a small employer a credit of up to 50% of "qualified start up costs." Start up costs include expenses incurred in the establishment or administration of the plan, and expenses attributable to retirement-related education of the employer's employees. The plan must cover at least one person who is not a highly compensated employee. The provision is designed to promote the establishment of qualified plans, SEPs or SIMPLE plans by small employers (generally 100 or fewer employees in prior year with compensation of $5,000 or more). The credit is available only for the first three years of the plan's existence, and any amount for which the employer claims a credit is not eligible for a deduction. The credit is first available for costs incurred in an eligible employer's taxable year that begins in 2002. Another Senate proposal to allow small employers a credit for a portion of their contributions to a qualified plan was dropped by the Conference Agreement.
• Roth 401k or 403b option starting in 2006. Section 617 of the new law adds new IRC §402A, which permits a 401(k) plan or 403(b) plan to allow a participant to designate all or part of his elective deferral as a Roth contribution. An elective deferral that is designated as a Roth contribution would not be excludable from gross income. Separate accounting for the Roth contributions (and attributable earnings) would have to be maintained. Qualified distributions from Roth accounts would be tax-free, just like qualified distributions from Roth IRAs. The taxation of the distributions attributable to Roth accounts would be the only special treatment for such contributions. Otherwise, the Roth contribution, along with any elective deferrals that are made on a pre-tax basis, are subject to the otherwise applicable limits (i.e., the dollar limit under IRC §402(g), the catch-up contributions rules for individuals over age 50, and the ADP nondiscrimination test under IRC §401(k) (other than catch-up contributions)). Roth accounts would be eligible for rollover only into Roth accounts under another 401(k) or 403(b) plan, or into a Roth IRA.
• Increased IRA contribution limits. Section 601 of the new law increases the $2,000 IRA contribution limit to $3,000 in 2002, 2003 and 2004, $4,000 in 2005, 2006 and 2007, and $5,000 in 2008. Starting in 2009, the $5,000 limit is subject to cost-of-living adjustments (in $500 multiples). Additional contributions are allowed for individuals who are age 50 or over, equal to $500 for 2002, 2003, 2004, and 2005, and $1,000 in 2006 (subject to cost-of living adjustments, in $500 multiples, starting in 2007). The law does not change the rules for deductibility. So, individuals who are active participants in qualified plans (as determined under current law) are not able to deduct the IRA contribution unless they do not exceed specified limits on adjusted gross income (current law AGI limits are retained).
• IRA accounts in defined contribution plans return! Starting in 2003, qualified defined contribution plans, 403(b) plans, and governmental 457(b) plans may allow participants to make IRA contributions to a separate account maintained under the plan. This is just like the old "qualified voluntary employee contribution accounts" or "deductible employee contribution" accounts that were allowed from 1982 through 1986. Everything old is new again!
• Hardship withdrawals - suspension relief, saner rollover rules. Treasury regulations currently require a 401(k) plan to suspend a participant's right to make elective deferrals or after-tax employee contributions for a period of one year following a hardship withdrawal if the plan is subject to the "safe harbor" hardship rules under those regulations. Section 636 of the new law requires the Treasury to reduce the mandatory suspension period to six months, for hardship withdrawals that occur after December 31, 2001. IRC §402(c)(4)(C) currently treats a hardship withdrawal of 401(k) contributions as ineligible for rollover, so that the mandatory withholding rule does not apply to such withdrawals. Section 631 of the new law applies this treatment to all hardship withdrawals, not just to those attributable to 401(k) contributions. This eliminates the need for the plan administrator to determine what portion of the hardship withdrawal is attributable to 401(k) contributions in order to administer the rollover and withholding rules.
• "Same desk" rule eliminated for 401(k) and 403(b) plans. The reference to "separation from service" is replaced by "severance from employment" in IRC §401(k)(2) and IRC §403(b), thereby eliminating the "same desk" rule problem in business acquisitions. So long as the buyer is not maintaining the seller's plan with respect to the transferred employees, distribution from the seller's 401(k) plan or 403(b) will be permitted to the transferred employees. The type of entities involved in the business transaction will not be relevant in determining whether a distribution event has occurred as it is under current law.
• User fee relief for small employers. Small employers are exempt from paying user fees on obtaining a determination letter for a new plan, so long as the determination letter is requested within the first 5 years of the plan (or at the end of a remedial amendment period, if later, that began during that first 5 years). Small employers are generally those who do not have more than 100 employees with compensation of $5,000 or more in the prior year.
• Provisions favoring funding of defined benefit plans. Section 651 of the new law repeals the current liability funding limit under IRC §412(c)(7) for plan years beginning in 2004 and later, with an increase in the funding limit for 2002 and 2003 before the limit is fully repealed. Section 652 amends IRC §404(a)(1)(D) to allow employers to make fully deductible contributions equal to the unfunded current liability, without regard to whether the plan has 100 or more participants (as under current law). However, if the plan has 100 or fewer participants, the liability attributable to benefit increases for highly compensated employees within the last 2 years is disregarded to compute the special deduction limit. When a plan subject to Title IV of ERISA is terminated, the amount needed to make the plan sufficient for benefit liabilities is substituted for unfunded current liability to determine the deduction limit for the employer. Section 653 of the new law amends IRC §4972(c) to permit an employer to disregard defined benefit plan contributions to determine whether the employer has made nondeductible contributions that are subject to the 10% excise tax under IRC §4972.
• Modifications to ERISA §204(h) notice requirements; enforcement primarily through excise tax. Under current law, ERISA §204(h) requires an employer to provide 15 days advance notice to participants when a pension plan is amended to substantial reduce the future rate of benefit accrual. Section 659 of the new law amends ERISA §204(h) to prescribe more specific notice requirements, but to modify the 15-day notice rule to a "reasonable period" before the effective date of the amendment, and allows the notice to be provided before the amendment is actually adopted by the employer. Failure to provide the notice, no longer results in a continuation of the pre-amendment formula, except under "egregious failures." The primary enforcement tool instead will be through an excise tax, imposed under new IRC §4980F, in the amount of $100 per day per individual who has not received the notice. There are waivers of the excise tax for certain failures where the employer has exercised "reasonable diligence." These modifications apply to amendments that take effect after the date of enactment of the new law, although the period for providing the notice will not end earlier than 3 months after such enactment date.
• Allocation restrictions under S corporation ESOPs. New IRC §409(p), as added by section 656 of the new law, prohibits allocations of employer securities to certain "disqualified persons" who are participants in an ESOP maintained by an S corporation. The purpose of the allocation restrictions is to ensure that ESOPs are established for S corporations in order to provide broad-based employee coverage and to benefit rank-and-file employees as well as highly compensated employees and historical owners. The effective date for S corporation ESOPs in existence on March 14, 2001, is not until the first plan year beginning after December 31, 2004. For an S corporation ESOPs established after March 14, 2001, the effective date is plan years ending after March 14, 2001 (e.g., calendar year 2001 for a plan with a December 31 plan year). In addition, if a corporation that maintained an ESOP as of March 14, 2001, was not an S corporation on that date, the nonallocation rules become effective as of the first plan year ending March 14, 2001, so that any change to an S corporation after March 14, 2001, immediately subjects the plan to the nonallocation rules.

No remedial amendment period prescribed by statute. The new law does not prescribe a special remedial amendment period for these new provisions. It is anticipated, however, that IRS will provided an extended amendment period. It is too soon to know at this time whether IRS will extend the GUST remedial amendment period to conform to the amendment period for the EGTRRA 2001.

Title I and Title IV provisions dropped. Except for Title I provisions that parallel the tax code amendments described above, or were integral to a tax code provision (e.g., the amendment of ERISA §204(h) to coordinate with the excise tax provision under new IRC §4908F, as described above), the Title I and Title IV provisions were dropped from the Conference Agreement. For instance, a provision that would have allowed terminated defined contribution plans to turnover account balances of missing participants to the PBGC was not included. Also, provisions to simplify some reporting rules and to grant the DOL authority to waive the penalty under ERISA §502(l) for fiduciary breaches, were not included.

Repeal of estate taxes.Title V of the new law repeals the estate tax, but not until 2010. Increased exemptions apply between 2002 and then. This will impact retirement savings, which for an increasing number of taxpayers has become a significant portion of the taxable estate and, for some, was the reason why the estate exceeded the exemption limits.

Sunset after 2010. In an unusual move, all of the amendments made by the new law expire for taxable years, limitation years, and plan years that begin after December 31, 2010. If Congress does not act to extend the provisions, the law would revert back to the rules as they exist today!

May 1 started wave of first plan years subject to DOL's small plan audit regulations (added May 2, 2001). In 2000, the DOL finalized regulations that subject certain small plans (i.e., plans with under 100 participants) to an audit requirement. The effective date of those regulations is plan years beginning after April 17, 2001. Thus, a plan with a plan year ending April 30, became subject to these regulations with its plan year that began May 1, 2001. To be exempt from the audit requirement, the plan, as of April 30, 2001, had to have at least 95% of its assets in "qualifying assets" (as defined in the regulation) or, have a fidelity bond that is no less than the value of the nonqualifying assets. If the plan fails to satisfy one of these conditions, it will have to include an audit report with its Form 5500 filed for the plan year beginning May 1, 2001, and ending April 30, 2002 (due on November 30, 2002, unless an extension applies). Other plans will begin to be subject to these regulations as they have their first plan year beginning after April 17, 2001. Note that calendar year plans will not be subject to the regulations until the 2002 plan year, because January 1, 2002, starts the first plan year that begins after April 17, 2001. It is expected that the majority of small plans will meet the regulatory requirements for the audit exemption. The regulations are DOL Reg. §2520.104-41(c) and §2520.104-46(b)(1) and (d). A summary of these regulations appears below in this What's New section (item was added October 21, 2000). More complete details were provided in the Winter 2001 Issue (Issue #20) of ERISA Views (Current Developments Section).

IRS approves another "wrap" arrangement between nonqualified plan and 401(k) plan (added April 23, 2001). In PLR 200116046, the IRS approves once again a "wrap" arrangement between a nonqualified plan and 401(k) plan. Here's how it works. Before the beginning of a calendar year (e.g., by December 31, 2000, for the 2001 calendar year), an employee who is eligible for the nonqualified plan elects to defer compensation through salary reduction. That election not only specifies the amount to defer into the nonqualified plan, it also specifies whether the "allowable deferral amount" in the 401(k) plan will be transferred to the 401(k) plan. The allowable deferral amount is the amount that is permitted, after taking into account the limit under IRC §402(g) (e.g., $10,500 in 2001), and after taking into account the limit under the ADP test (i.e., the nondiscrimination test prescribed by IRC §401(k)(3)). The allowable deferral amount also takes into account whether the 401(k) contribution would cause the employee's total annual additions for the year to exceed the §415 limit (i.e., the lesser of $35,000 or 25% of compensation). If the employee elects to transfer the allowable deferral amount, that amount is transferred by March 15 following the close of the calendar year (i.e., by March 15, 2002, for the 2001 calendar year). If the employee does not elect to transfer the allowable deferral amount, the amount is paid in cash to the employee by the March 15th date. (The cash payment option is necessary, even though the employee typically elects the transfer, in order to characterize the transfer to the 401(k) plan as a "cash or deferred" contribution. The requirement to transfer or pay cash by March 15, is to comply with the 2-1/2 month rule in the 401(k) regulations, which states that an amount is an elective deferral for a year if it represents compensation that would otherwise be payable to the employee within 2-1/2 months after the close of the year.) Through this arrangement the employee is able to ensure that the total amount will be deferred, without having to gamble by deferring directly into the 401(k) plan and chance having a portion of that amount refunded as an excess deferral under 402(g) or an excess contribution under the ADP test. For example, suppose the eligible employee will earn $300,000 in 2001, and, by December 31, 2000, elected to defer $30,000 of that amount (i.e., a 10% deferral rate)to the nonqualified plan. As a result, 10% of the employee's compensation is deducted through salary reduction and contributed to the rabbi trust that has been set up by the employer to accept contributions under the nonqualified plan. The employee also elected to have the allowable deferral amount transferred to the 401(k) plan after the appropriate limits were determined for 2001. On February 20, 2002, it is determined that $9,200 of the employee's deferrals could have been made to the 401(k) plan without violating the limits under IRC §402(g) or IRC §415, and without violating the ADP test. Thus, by March 15, 2002, $9,200 of the employee's $30,000 total deferral amount is transferred into the 401(k) plan from the nonqualified plan's rabbi trust. The remaining $20,800 stays in the rabbi trust.

• May include matching contribution, too. These "wrap" arrangements may include a matching contribution, too. In fact, the plan described in PLR 200116046 included a matching contribution. In our example in the prior paragraph, suppose the 401(k) plan provides for a 50% match. The nonqualified plan would mirror that matching formula, so that the employee would get a matching contribution of $15,000 (i.e., 50% x $30,000). Then, after the close of 2001, it would be determined how much of the match can be transferred to the 401(k) plan without violating the §415 limit nor the ACP nondiscrimination test under IRC §401(m). The match on $9,200, which is the allowable deferral amount transferred to the 401(k) plan, would be $4,600. If that amount could be transferred without violating §415 or the ACP test, then the entire corresponding match also would be transferred to the 401(k) plan from the nonqualified plan, and the remaining $10,400 of the match stays in the rabbi trust. If less than $4,600 is permissible, then the lesser amount is transferred to the 401(k), and the difference stays in the rabbi trust.

Salary reduction contributions to purchase qualified transportation fringe benefits now part of compensation under IRC §415/retroactive effective date will require IRS transition guidance (added March 2, 2001; updated March 3, 2001). The Consolidated Appropriations Act, 2001 (Public Law 106-554) included what was mostly minor technical corrections to some of the pension provisions in the tax code. But one change has an important effect on the computation of compensation under IRC §415. As amended, IRC §415(c)(3)(D) now includes salary reduction contributions to purchase qualified transportation fringe benefits, as described in IRC §132(f)(4), in the definition of compensation used to compute the §415 limits (e.g., the 25%-of-compensation annual additions limit for defined contribution plans). IRC §132 allows an employer to provide a "qualified transportation fringe" to employees which is excludable from gross income up to the limits prescribed by §132(f)(2). A qualified transportation fringe benefit includes the cost of transportation in a "commuter highway vehicle" (as defined in §132(f)(5)(B)), any transit pass (as defined in §132(f)(5)(A)), and qualified parking (as defined in §132(f)(5)(C)). Note that employers may not offer this type of fringe as a benefit option under a cafeteria plan (see IRC §125(f)). Thus, the amendment to §415(c)(3)(D) made by the Small Business Job Protection Act of 1996 to include salary reduction contributions under a cafeteria plan in the definition of §415 compensation, effective for years beginning after December 31, 1997, did not bring in the salary reduction amounts used to purchase qualified transportation fringe benefits under IRC §132(f)(4). If an employer is allowing employees to purchase qualified transportation fringe benefits through salary reduction, the salary reduction contributions also must be included in §415 compensation because of this law change.

Caution: retroactive effective date. The Consolidated Appropriations Act, 2001, makes this change to §415(c)(3)(D) retroactive to years beginning after December 31, 1997, which is the same year that the inclusion of elective deferrals under cafeteria plans was included in the definition of §415 compensation. This means that for years beginning in 1998, 1999, and 2000, plans may have been administered incorrectly the §415 limits, and other tax code provisions that rely on the §415 compensation definition (see next paragraph). The IRS will need to provide transition guidance. The IRS should consider deeming plans to have satisfied the §415 compensation definition for years beginning prior to a certain date, regardless of whether the plan recognized salary reduction contributions for qualified transportation fringe benefits in the definition of compensation.

What other tax code provisions use §415 compensation? The definition of compensation under §415(c)(3) is used not only to compute the §415 limits, but to determine compensation for identifying highly compensated employees under IRC §414(q), identifying key employees under IRC §416(i), and for calculating the minimum benefit required under top heavy plans under IRC §416(c). Furthermore, for nondiscrimination testing purposes, one of the "safe harbor" definitions for calculating compensation under IRC §414(s) is to use §415 compensation, or to modify that definition by excluding the elective deferrals listed in §415(c)(3)(D) (which now includes qualified transportation fringe benefits purchased through salary reduction).

PWBA clarifies position on payment of qualification-related expenses by the plan (added January 28, 2001). The PWBA issued a news release to clarify its position regarding the payment of expenses by a plan. The clarifications are in two sources: 1) PWBA Advisory Opinion 2001-01A, and 2) six hypothetical fact patterns. Both are available at the PWBA website: www.dol.gov/dol/pwba. The bottom line - expenses relating to the maintenance of plan qualification are payable by the plan and do not have to be allocated between the plan and the employer, even though the employer derives an incidental benefit from the plan's tax qualification; expenses relating to choices the employer has as a plan sponsor, even if related to law changes that affect the qualification requirements, are settlor expenses.

• Advisory Opinion 2001-01A. When determining whether fees are "settlor" expenses (i.e., relating to the establishment, design and termination of a plan) or "fiduciary" expenses (i.e., relating to the necessary operation and administration of the plan, including administrative activities that become necessary after there is a decision to establish, amend or terminate a plan), a fiduciary is not required to take into account the benefit a plan's tax-qualified status confers on the employer. Any such benefit derived by the employer from tax qualification of the plan is an integral component of the incidental benefits that flow to plan sponsors generally by virtue of offering a plan. The formation of a plan that is tax-qualified is a settlor activity for which the plan may not pay (i.e., fees associated with the feasibility and design of the plan). However, implementing the settlor decision to have a plan may require plan fiduciaries to undertake activities relating to maintaining the plan's tax qualified status, for which the plan may pay reasonable expenses. Implementation activities include drafting plan amendments required by law changes, nondiscrimination testing, and requesting IRS determination letters. On the other hand, if maintaining the plan's qualified status involves the analysis of options for amending the plan, from which the plan sponsor can make a choice, the expenses incurred in analyzing the options would be settlor expenses that the plan could not pay.
• Six hypotheticals. In six hypothetical situations the PWBA lists expenses by category, and determines whether the expenses are settlor or fiduciary expenses. Only those identified as fiduciary expenses may be paid by the plan (assuming the fee charged is reasonable). Here are some expenses identified as properly payable by the plan: 1) restatements needed for GUST amendments, 2) nondiscrimination testing necessitated by plan features (e.g., ADP testing for a 401(k) plan), or by a plan amendment to add certain plan features (the additional of a loan program that may need to be tested for nondiscriminatory availability), 3) application for determination letter from the IRS on a plan amendment, even for an amendment that was adopted solely because of design decisions made by the employer, 4) costs of computing benefits due to a corporate transaction resulting in an agreement to spin-off benefit liabilities from a plan, 5) preparation of participant disclosure documents (e.g., individual benefit statements). Expenses that are not payable by the plan are those that relate to the employer's settlor function (i.e., establishment, design or termination of plan), including analysis of design options relating to a law change, expenses relating to union negotations that affect plan design, analysis plan amendments to the plan's design and, to the extent amendments are not necessitated by law changes, the cost of adopting the plan amendments, expenses relating to financial accounting (various FASB statements).

IRS reissues procedures under EPCRS - VCR and Walk-in CAP merged into single submission program; VCGroup submission allows global correction by service provider; SEPs added to program; errors relating to transferred assets in plan mergers addressed; self-correction through retroactive amendments allowed for certain violations; "John Doe" proceedings formalized (added January 22, 2001). Rev. Proc. 2001-17, released to the public today, replaces Rev. Proc. 2000-16, governing the procedures for correction qualification failures through the IRS' Employee Plans Compliance Resolution System (EPCRS). Rev. Proc. 2000-17 applies to: 1) self-correction of qualification failures completed on or after May 1, 2001 (newly designated SCP procedure, replacing the former APRSC procedure), 2)correction of failures through voluntary submissions with IRS submitted on or after May 1, 2001 (newly designated VCP, replacing the former VCR, Walk-in CAP and TVC procedures), and 3) correction of qualification failures discovered under IRS examinations begun on or after May 1, 2001 (still designated as Audit CAP). However, the new procedures may be applied earlier, at the election of the plan sponsor (or the "Eligible Organization," in the case of a group submission under "VCGroup" procedures). Here is a brief summary of the major changes made by Rev. Proc. 2001-17. The Spring 2001 Issue of ERISA Views (Issue #21) will devote its Focus Topic to the revised EPCRS procedures.

• Replacement of VCR, Walk-in CAP, and TVC with single program, but the alphabet soup continues. Under the old procedures, voluntary submissions were divided into three basic categories: VCR (Voluntary Compliance Resolution), available only to correct Operational Failures in Qualified Plans with "Favorable Letters," Walk-in CAP (voluntary closing agreement program), available to correct all Qualification Failures in Qualified Plans (regardless of whether they have Favorable Letters), and TVC (Tax-Sheltered Annuity Voluntary Compliance), to correct Qualification Failures in 403(b) plans. Rev. Proc. 2001-17 includes all of the voluntary submission programs into a single umbrella called VCP, which stands for Voluntary Compliance Program. The general VCP procedure corresponds most closely to the old Walk-in CAP, with a similar compliance fee structure. Any Qualification Failure (Operational, Plan Document, Demographic) under a Qualified Plan (plan described in IRC §401(a)) may be corrected under the general VCP procedure, regardless of whether the plan has a Favorable Letter. However, under VCP are 5 subcategories: 1) VCO, analogous to the old VCR procedure, under which Operational Failures under a Qualified Plan with a Favorable Letter may be corrected through a reduced compliance fee that is identical to the old VCR compliance fee, 2) VCS, analogous to the old Standardized VCR (SVP) procedure, under which Operational Failures described in Appendix A or Appendix B of Rev. Proc. 2001-17, may be corrected with a flat compliance fee of $350 (same as the old SVP fee), regardless of the size of the plan, so long as the plan has a Favorable Letter and is not fixing more than two categories of the failures listed in Appendixes A and B, 3) VCT, analgous to the old TVC procedure, under which a section 403(b) plan may participate in the VCP to correct an Operational Failure, Demographic Failure or Employer Eligibility Failure, under the same compliance fees as were imposed under TVC, 4) VCGroup, a new type of submission, by the sponsoring organization of an M&P plan, an insurance company that issues 403(b) contracts, or other organization that offers administrative services (e.g., TPA firm), to seek a "global" correction of 20 or more plans affected by the Qualification Failure under a group-based fee rather than a fee calculated for each plan, and 5) VCSEP, a new type of submission, by the plan sponsor of a Simplified Employee Pension (SEP), including a salary reduction SEP (SARSEP), under the normal VCP (or VCO, if applicable) compliance fee structure.
• Self-correction program redesignated as SCP; extended correction period with respect to certain transferred assets. The former Administrative Policy Regarding Self-Correction (APRSC) has been redesignated as SCP (for "Self- Correction Program). The rules are substantially the same as under the old procedures. Insignificant violations may be corrected at any time, even if the plan is under audit, and even if the IRS auditor is the one who discovers the error. Signficant violations generally may not be corrected after the second plan year following the year of the failure. However, if a significant failure relates to transferred assets from another plan, due to a corporate merger, acquisition, or similar business transaction, the new SCP allows such failure to be corrected up to the last day of the plan year that begins after the transfer of assets, even if the failure occurred more than two plan years earlier (i.e., prior to the transfer of the assets).
• Fees for late amenders clarified. Although the compliance fee structure is largely unchanged, section 12.01(2) provides specific penalty standards for late amenders. If the failure relates only to UCA and/or OBRA '93 amendments, the fee is the halfway point between the minimum fee for VCP (which is the fee that would apply under VCO) and the presumptive fee. If the failure relates to TRA '86, the fee is the presumptive amount for VCP. If the failure relates to TEFRA, DEFRA, REA, the fee is halfway between the presumptive amount and the maximum fee for VCP. If the failure relates to ERISA, the fee is the maximum fee for VCP.
• Clarification of uses of plan amendments to correct Operational Failures; retroactive inclusion of ineligible employee under plan allowed under certain circumstances. An employer may use the general VCP procedures to request permission to amend the plan to fix an Operational Failure, rather than to conform the operation of the plan to the terms of the plan document. In addition, through SCP (i.e., without IRS involvement) or through VCO, an employer may correct by retroactive plan amendment any of the failures specified in section 2.07 of Appendix B of Rev. Proc. 2001-17. These failure are: 1) retroactive adjustment of the contribution formula to reflect a contribution made on the basis of compensation in excess of the compensation dollar limit under IRC §401(a)(17), 2)retroactive amendment to authorize prior hardship withdrawals, and 3) retroactive expansion of the plan's eligibility conditions so that an ineligible employee is properly included in the plan on a retroactive basis. The failures described in 1) and 2) were also in the old procedure, but Rev. Proc. 2001-17 now permits the amendments to be adopted through SCP, rather than having to apply for permission through VCP, if the applicable correction period under SCP is still open. The failure in 3) avoids having to correct improperly made deferrals and/or after-tax contributions made by the ineligible employee, or to forfeit matching contributions and/or employer contributions allocated to the employee's account. In order to use the retroactive amendment procedure to include an eligible employee, the amendment must otherwise satisfy §401(a) (e.g., it cannot result in prohibited discrimination or violate the §415 limits) and the employees affected by the amendment must be predominantly nonhighly compensated. If retroactive inclusion applies to a §401(k) or §401(m) arrangement, the retroactively-included employee(s) will need to be included in the applicable ADP or ACP test. Rev. Proc. 2001-17 did not, however, add an operational correction method for the inclusion of ineligible employees. For guidance of how to fix this problem as an operational failure, rather than under the retroactive amendment procedure described in this paragraph, see Issue #2 in the Problem Resolution Table provided in Chapter 15, Section VI, Part D., of the 2001 Edition of The ERISA Outline Book.
• Formal "John Doe" procedures. Rev. Proc. 2001-17 formalizes the "John Doe" proceedings, designated as the Anonymous Submission Procedure. The Anonymous Submission Procedure may be used under any VCP submission category. A formal submission must be made by a representative, with identifying information deleted. The IRS will work through the case with the representative and come to an agreement on the method of correction. The plan sponsor will have 21 days from the date of the letter of agreement to identify itself and the plan(s) involved. An initial compliance fee is submitted with an anonymous submission, as prescribed by section 12.06 of Rev. Proc. 2001-17, which is not refunded, even if the plan sponsor chooses not to come forward and accept the agreement.
• VCGroup submission. The VCGroup submission may be an ideal way to correct operational failures or document failures that resulted from errors made by an M&P sponsor, insurance company, or other service provider, where the total compliance fee may be much less than if each affected employer applied for relief separately. The initial fee, which is paid up front, is $10,000. Upon closing the case, an additional fee is assessed in the amount of $125 times the number of affected plans in excess of 20, with a $40,000 maximum, if the correction is made under Appendix A or Appendix B of Rev. Proc. 2001-17, or $250 times the number of affected plans in excess of 20, with a $90,000 maximum, in all other cases. Of course, if the error can be fixed through SCP, no IRS submission would be needed and no compliance fees would be paid.
• Where to send submissions. VCO, including a VCO application made through the Anonymous Submission Procedure, VCGRoup and VCSEP submissions are sent to the IRS' headquarters in Washington, D.C. Other VCP applications are made with one of four IRS regional offices. The addresses are in section 11.12 of Rev. Proc. 2001-17.
• Ineligible Employer failure added for 401(k) plans. If a tax-exempt organization adopted a 401(k) plan for one or more years between 1987 and 1996 (inclusive), even though such employers were precluded from establishing 401(k) plans during such year, that error can be corrected under VCP (but not VCO or VCS). The 401(k) contributions made by the employees during the ineligible years do not lose their qualified plan status. A similar option applies under VCSEP for employers who sponsored SARSEPs but were not eligible to do so (e.g., exceeded the 25-eligible-employees maximum).
• Automatic waiver of minimum distribution excise tax. If there has been a failure to satisfy the minimum distribution requirements, the IRS will waive the 50% excise tax under IRC §4974, but only if the plan sponsor is applying for relief through VCP (including an of the appropriate subcategories of VCP, such as VCT or VCSEP). However, if the participant is an owner-employee, as defined in IRC §401(c)(3), or a 10% or more owner of a corporate plan sponsor, an explanation supporting the waiver request must be attached.
• Correction guidance largely unchanged. The correction guidance in Appendixes A and B, as well as the general correction guidance in section 6 of Rev. Proc. 2001-17, are largely unchanged, with only some minor clarifications, except for the addition of the retroactive amendment correction method for including ineligible employees, as discussed above.
• Revised checklist. The checklist in Appendix C has been revised to reflect the new designations in the procedure and to make some other clarifying changes. The checklist must be included at the top of any VCP submission.

IRS proposes to substantially simplify the calculation of required minimum distributions under IRC §401(a)(9); plans may elect to start applying new rules in 2001 (added January 12, 2001). New proposed regulations made public today significantly simplify the calculation of minimum distributions under IRC §401(a)(9), particularly for IRAs and defined contribution plans. During the lifetime of an employee or IRA owner (referred to in the rest of this summary as the "participant"), minimum distributions for a calendar year may be calculated under these proposed regulations by using the minimum distribution incidental benefit (MDIB) factor applicable to the individual's age for that calendar year. The MDIB factor is based on the joint life expectancy (determined under the tables published in §1.72-9) for the participant and an assumed beneficiary who is 10 years younger than the participant. (This Table is reproduced in Appendix B to Chapter 6 of The ERISA Outline Book.) The MDIB factor can be used regardless of who the designated beneficiary is or even whether there is a designated beneficiary. Thus, a participant who has named his estate or an organization (e.g., church) as his beneficiary could still take minimum distributions based the MDIB factor (current rules would require use of the participant's single life expectancy under these circumstances). If the participant's designated beneficiary is his or her spouse, and that spouse is more than 10 years younger than the participant, the joint life expectancy factor, as determined under §1.72-9, could still be used. By using the MDIB factor as the standard, the proposed regulations also eliminate the need to identify the designated beneficiary as of the required beginning date (i.e., the date that minimum distributions are required to start to the partiicpant), or to determine whether to recalculate life expectancies. Furthermore, changes in the participant's beneficiary that occur after his required beginning date but before his death would have no impact on the applicable life expectancy factor used to calculate minimum distributions (except where a joint life expectancy, based on a spouse who is 10 or more years younger, is used). When the participant dies, the relevant designated beneficiary for post-death minimum distributions is simply determined as of the end of the calendar year following the participant's death. Distributions are calculated using the designated beneficiary's remaining life expectancy as of that year, and subtracting "1" for each subsequent year. If the participant's beneficiary is the estate, or an entity (e.g., church), or a trust that doesn't satisfy the requirements for looking to the underlying beneficiaries of that trust, the post-distribution period would be based on the participant's remaining life expectancy in the calendar year of his death (i.e., using the single life expectancy tables in §1.72-9) and subtracting "1" for each subsequent year. WIth the simplification of the minimum distribution rules, the Treasury is contemplating the introduction of a new reporting requirement of IRA trustees/custodians/issuers. Under the new reporting requirement, the IRA owner would have to receive an annual reporting of the amount that would satisfy the minimum distribution rules for that year. There will be no such reporting rules until later guidance is issued. Starting in 2001, a plan (or IRA owner) may elect to apply the new rules in these proposed regulations, even for years beginning before the publication of final regulations. However, to use these rules, a plan must adopt a model amendment, which is set forth in the proposed regulations. The model amendment may be effective as of January 1, 2001, or as of any later January 1. If the model amendment is not adopted, the plan must continue to follow the rules in the 1987 proposed regulations. When IRS issues opinion letters, advisory letters or determination letters under GUST, those letters will not address these new regulations. GUST-approved plans, however, will not lose their reliance on their IRS approval letters if the model amendment is adopted to incorporate the new proposed regulations. Subscribers to ERISA Views will receive a more thorough discussion in the Winter 2001 issue being published within the next two weeks.

IRS clarifies extended remedial amendment period for M&P plans and volume submitter plans - addresses multiple master/prototype plans (M&P plans) or specimen plans sponsored by the same organization (added January 11, 2001; amended January 18, 2001). If the conditions of Rev. Proc. 2000-20 are satisfied, the GUST remedial amendment period for an employer's plan ends on the later of: 1) the last day of the 2001 plan year (which is the regular GUST amendment period), or 2) the end of the 12 months following the issuance of the GUST opinion letter on the M&P plan or the GUST advisory letter on the volume submitter specimen plan. If an employer does not meet the conditions of Rev. Proc. 2000-20, then the GUST amendment period ends on the last day of the 2001 plan year, which is the regular amendment deadline prescribed by Rev. Proc. 2000-27. To be entitled to the later deadline under Rev. Proc. 2000-20, an employer must satisfy one of two conditions: 1) adopt an M&P or volume submitter specimen plan (regardless of whether that plan has a TRA '86 opinion letter or advisory letter), or 2)jointly certify with an M&P sponsor or volume submitter practitioner that the employer intends to amend its plan for GUST by adopting the sponsor or practitioner's M&P or volume submitter specimen plan after the plan has received GUST approval. One of these two conditions must be satisfied by the employer no later than the last day of its plan's 2001 plan year. In addition, the M&P sponsor or volume submitter practitioner must have submitted its M&P plan or volume submitter specimen plan for GUST approval no later than December 31, 2000. Note that the December 31, 2000, submission deadline for the M&P sponsor or volume submitter practitioner has passed and is not being extended. Announcement 2001-12 clarifies some issues about the 12-month amendment period granted by Rev. Proc. 2000-20. (Note: IRS originally notified the public that this new guidance would be designated as Announcement 2001-6, but corrected the citation on January 18, 2001.)

Firms that sponsor more than one M&P or volume submitter plan. One area that Announcement 2001-12 clarifies is the measurement of the 12-month period when a firm sponsors more than one M&P plan, more than one volume submitter specimen plan, or a combination of M&P plans and volume submitter specimen plans. An employer who has adopted (or certified its intent to adopt) a sponsor or practitioner's M&P plan or volume submitter specimen plan by the end of the 2001 plan year is deemed to have adopted each other M&P plan or volume submitter specimen plan of that sponsor or practitioner. Thus, if the M&P plans and/or volume submitter specimen plans of the sponsor or practitioner receive GUST approval in different months, the latest 12-month period will apply to all employers who have met one of the two conditions above with respect to that M&P sponsor or volume submitter practitioner.

• Example 1. A bank sponsors two M&P plans. Employer X adopted M&P Plan 1 in 1994. Employer Y adopted M&P Plan 2 in 1997. Both plans were approved under TRA '86. M&P Plan 2 is an mass submitter document. M&P Plan 2 is a non-mass-submitter document. The bank's GUST opinion letter applications for both M&P plans were submitted by December 31, 2000. The GUST opinion letters for M&P Plan 1 are issued in April 2001. The GUST opinion letters for M&P Plan 2 are issued in September 2001. The 12-month period under Rev. Proc. 2000-20 ends September 30, 2002, with respect to adopters of both M&P plans. This is because, as clarified in Announcement 2001-12, Employers X and Y are deemed to have adopted both M&P plans for purposes of determining the 12-month period under Rev. Proc. 2000-20. The applicable 12-month period is the one which ends the latest (i.e., the 12-month period with respect to the GUST opinion letters issued for M&P Plan 2).
• Example 2. A law firm sponsors three volume submitter specimen plans, one profit sharing plan without a 401(k) arrangement (Specimen Plan 1), one profit sharing plan with a 401(k) arrangement (Specimen Plan 2), and one money purchase plan (Specimen Plan 3). Employer A has adopted Specimen Plans 1 and 3. Employer B has adopted Plan 2. Employer C has adopted Specimen Plans 2 and 3. All three employer adopted the pre-GUST versions of these specimen plans. The law firm submitted all three specimen plans for GUST advisory letters by December 31, 2000. The advisory letters for Specimen Plan 1 and Specimen Plan 3 are issued in April 2001. The advisory letter for Plan 2 is issued in July 2001. Employers A, B and C are all deemed to have adopted all three specimen plans for purposes of determining the 12-month GUST amendment period under Rev. Proc. 2000-20. Thus, July 31, 2002, deadline measured with reference to the advisory letters issued on Specimen Plan 2, which is the end of the latest 12-month periods, applies to all three employers. In addition, the July 31, 2002, deadline applies to both plans adopted by Employer A and both plans adopted by Employer C.

Announcement 2001-12 also provides relief when an employer has adopted the plan of an M&P plan sponsor or volume submitter practitioner who merged into another M&P sponsor or volume submitter practitioner before January 1, 2001, or whose M&P plan or volume submitter plan is being replaced by another company within the same controlled group. If the conditions for this relief are satisfied, the adopting employer of the replaced plan is entitled to the 12-month amendment period measured with reference to the GUST opinion letters or advisory letters issued to the sponsor of the replacement plan. More details on Announcement 2001-12, including additional examples, will appear in the Winter 2001 issue of ERISA Views (expected to be published before the end of January).

Updated procedures for rulings, determination letters, user fees issued for 2001 (added January 11, 2001). The IRS has issued its annual updates for private letter rulings on employee plans matters (Rev. Proc. 2001-4), technical advice on employee plans matters (Rev. Proc. 2001-5), determination letters on qualified plans (Rev. Proc. 2001-6), and user fees (Rev. Proc. 2001-8). For the most part, only technical changes are made to these procedures, including updating of mailing addresses to reflect the restructuring of the IRS, pursuant to the IRS Restructuring and Reform Act of 1998. User fees for private letter rulings, determination letters, opinion letters on M&P plans, and advisory letters on volume submitter specimen plans are unchanged from the fees stated in last year's procedure (Rev. Proc. 2000-8).

• No pre-GATT or GUST I letters may be requested for individually-designed plans after March 3, 2001. In Rev. Proc. 2000-27 the IRS describes three types of determination letters: pre-GATT letters (no GUST issues considered), GUST I letters (only pre-1999 GUST changes considered), and GUST II letters (full GUST review). Rev. Proc. 2001-6 provides that pre-GATT and GUST 1 letters may not be requested for individually-designed plans (including adopters of volume submitter specimen plans) after March 3, 2001. The determination letter application for an adopter of an M&P plan will continue to be reviewed on the basis of the scope of review of the underlying M&P plan. Thus, adopting employers of an M&P plan who submit for determination letters will receive GUST II determination letters only after the M&P plan receives GUST approval under Rev. Proc. 2000-20. If the plan is submitted for a determination letter before then, the determination letter will be a pre-GATT letter, if the M&P plan has not received any GUST approval, or a GUST I letter, if the M&P plan was approved for pre-1999 GUST amendments, pursuant to Rev. Proc. 98-14.

IRS updates P.S. 58 cost table for valuing life insurance protection (added January 11, 2001). Notice 2001-10 updates the IRS' P.S. 58 cost table. This is the first update since 1955 (the current table is found in Rev. Rul. 55-747). Table 2001, as published in Notice 2001-10, using updated mortality, which results in significantly less income inclusion with respect to life insurance protection purchased under a qualified plan. For example, a participant age 40 with $100,000 of net insurance protection, would have had reportable P.S. 58 costs of $442 under Rev. Rul. 55-747, but only $110 of P.S. 58 costs under Table 2001. Plan administrators may start using Table 2001 immediately. However, administrators may continue using Rev. Rul. 55-747 for taxable years ending on or before December 31, 2001. Thus, for purchases of life insurance in 2001, the administrator may use the table in Rev. Rul. 55-747 or Table 2001 in Notice 2001-10 to calculate P.S. 58 costs, but for purchases of life insurance after 2001, only the table in Notice 2001-10 (or a subsequently published replacement table) will be available. Plan administrators may continue to use the insurer's rates for standard risk term insurance, in lieu of the rates published in Table 2001 (or Rev. Rul. 55-747, if applicable), but only if the insurer's rates are less than the rates in the applicable table. Administrators should find that with the updated mortality reflected in Table 2001, the rates in that table will compare favorably with the insurer's rates and there will be little difference in the P.S. 58 cost income reported to the participants regardless of whether Table 2001 or the insurer's rates are used. Administrators may elect to use Table 2001 rather than hassle with having to request the insurer's rates. In addition, after December 31, 2003, new restrictions will apply to the use of the insurer's rates in lieu of the IRS-published rates.

PBGC proposes amendments to expand benefit payment options under PBGC-trusteed plans (added January 11, 2001). PBGC has issued proposed regulations (65 F.R. 81456 - published in the December 26, 2000, Federal Register) that will expand the optional forms of benefit a participant may elect under a PBGC-trusteed terminated defined benefit plan. The options include various guaranteed term single life annuities (i.e., life annuity with 5, 10 or 15 years guaranteed) and various joint and survivor annuities (i.e., 50%, 75% or 100% survivor annuity, as well as a 50% "pop-up" survivor annuity that increases the annuity to the participant if the survivor annuitant predeceases the participant). The joint and survivor annuities could be elected with non-spouse beneficiaries as well. The proposal also clarifies how underpayments to the participant would be paid if the participant dies before PBGC restores the underpayment, or how guaranteed payment streams (e.g., annuity with 10 years guaranteed) would be paid if the original beneficiary predeceases the participant. In addition, the proposal would no longer aggregate benefits payable with respect to more than one participant to determine the maximum guaranteed benefit under a terminated plan. For example, if an individual is a participant under a terminated plan, but is also the beneficiary of a deceased participant under that plan, the benefits payable from that plan in the individual's participant capacity would not be aggregated with benefits payable in the individual's beneficiary capacity to determine the maximum guaranteed benefit. Thus, if the maximum guaranteed benefit is $3,000 per month, and the individual's participant benefit is $2,500 per month and the individual's survivor benefit is $1,000 per month, the individual will receive $3,500 per month. Under present rules, the benefits would be aggregated and capped at $3,000 per month. Finally, the proposal would create a new definition, the Earliest PBGC Retirement Date, which would be used to determine whether an individual has a category 3 priority under PBGC Reg. §4044.13 (which applies to certain participants who were eligible to retire within 3 years before the termination date). The Earliest PBGC Retirement Date generally would not occur earlier than age 55, even if the plan would allow a participant to separate from service and commence an annuity distribution before such age. The PBGC will not implement any of these changes until it adopts the amendments in final form. The amended rules will generally be effective for benefits that go into pay status (or deaths that occur) after the effective date of those rules.

Additional delay in effective date of nondiscrimination testing rules for certain governmental plans and nonelecting church plans (added January 11, 2001). Governmental plans that are maintained by State or local governments (or political subdivisions or instrumentalities of State or local governments) are deemed to satisfy the nondiscrimination testing rules under IRC §§401(a)(4), 401(a)(26), 401(k) and 401(m). Notice 99-40 deems other governmental plans to satisfy such requirements until the 2001 plan year (i.e., the plan year that begins in 2001). The IRS has now issued Notice 2001-9, which delays the application of the nondiscrimination testing rules for these other governmental plans until the 2002 plan year (i.e., the plan year that begins in 2002). Before the 2002 plan year, these other governmental plans are also deemed to satisfy the nondiscrimination testing rules. Note that this notice has no effect on State or local governments, whose plans are permanently deemed to satisfy these requirements, even in post-2001 plan years. Nonelecting church plans are not deemed to satisfy the nondiscrimination testing rules. However, Notice 99-40 delayed the effective date of the regulations under IRC §§401(a)(4), 401(a)(5), 401(l) and 414(s) until the 2001 plan year. Notice 2001-9 further delays the effective date of these regulations until the 2002 plan year. Until the regulations become effective, nonelecting church plans must be operated in accordance with a reasonable, good faith compliance interpretation of the statutory provisions. Note that the good faith compliance standard does not apply to the 401(k) and 401(m) regulations.

Participant may adjust periodic payments from IRA following divorce without triggering make-up penalties under §72(t) (added January 11, 2001). There have been a number of private letter rulings where an individual commences periodic payments from an IRA, prior to his attaining age 59-1/2, and subsequently gets divorced. PLR 200050046 is probably the clearest ruling yet issued by the IRS, clarifying what flexibility the individual has in adjusting annual payments on a post-divorce basis and the treatment of the portion of the IRA awarded to the former spouse. In PLR 200050046, the individual was receiving annual payments from his IRA equaling $300,000 per year. Pursuant to the divorce, the individual's former spouse was awarded approximately one-third of his IRA which was transferred to a separate IRA in accordance with IRC §408(d)(6). The IRS made the following rulings. 1) Following the divorce, the former spouse is under no obligation to continue periodic payments from the portion of the IRA awarded to the former spouse. Thus, whether or not the former spouse continues periodic payments from her IRA, or how she calculates payments that she chooses to take from her IRA, has no bearing on whether the individual has modified his periodic payments from his post-divorce IRA. 2) Since the amount of the individual's periodic payments were based on an IRA that included the amount eventually awarded to the former spouse in the divorce, it is reasonable for the individual to reduce his annual payments to reflect his post-divorce share of his IRA. Thus, the reduction of his annual payments by approximately one-third, which reflected the marital division, was not a substantial modification of his periodic payments within the meaning of IRC §72(t)(4), and no make-up penalties apply.

ERISA §204(h) notice applied to converison of money purchase plan to profit sharing plan; benefit claim under pre-amendment formula timely more than 6 years after conversion (added January 11, 2001). In Brothers v. Miller Oral Surgery Inc. Retirement Plan, 25 EBC 1369 (3rd Cir. August 31, 2000), Miller Oral Surgery Inc. ("Miller") restated its money purchase plan into a discretionary profit sharing plan. Although amendment documents were signed, no notice was given to participants, as required by ERISA §204(h). The court determined that the conversion of the money purchase plan into a discretionary profit sharing plan triggered a notice requirement under §204(h), because the discretionary contribution nature of the amended plan has the potential for substantially reducing the rate of future benefit accrual. Since a section 204(h) notice was not given, the pre-amendment terms of the plan continued, entitling Brothers, a plan participant, to additional contributions in accordance with the old money purchase contribution formula. Interesting issues regarding standing and the applicable statute of limitations also arose in the case. Miller argued that Brothers' claim was under ERISA §502(a)(3), to enforce the notice provisions under ERISA §204(h), thereby subjecting the claim to the 6-year statute of limitations under ERISA §413, which is measured from the time the amendment occurred. If this argument prevailed, Brothers' suit would have been untimely. However, the court determined that Brothers' suit is a claim for benefits under ERISA §502(a)(1)(B). As a claim for benefits, Brothers has standing as a "participant," because he is claiming additional benefits. This triggers the need to determine the terms of the plan, which requires the court to determine the effect of failing to provide the section 204(h) notice. Furthermore, the statute of limitations period is measured from the denial of the benefit claim, not the date the amendment was adopted, and Brothers' claim was filed timely on that basis.

PBGC clarifies deadline for 2000 ERISA §4011 notice (added December 7, 2000). ERISA §4011 requires a plan that is subject to the PBGC variable rate premium to issue a notice to participants. The due date of the notice for a plan year is two months following the deadline for filing Form 5500 for the prior plan year. Calendar-year plans were granted a filing extension for the 1999 Form 5500 to October 16, 2000. Thus, the 2000 ERISA §4011 notice was also extended to December 18, 2000 (i.e., the first business day after December 16, 2000). If the employer is late on giving the notice, the PBGC may assess penalties, but it has the authority to waive penalties for reasonable cause. The PBGC warns that it generally will not consider transition year difficulties resulting in late filing of the 1999 Form 5500 as establishing reasonable cause for a late issuance of the 2000 ERISA §4011 notice. The PBGC believes the information needed to provide the notice on a timely basis is generally unaffected by whether the plan was able to satisfy its 1999 Form 5500 filing deadline.

$35,000 limit for DC plans takes effect for years ending after December 31, 2000 (added December 5, 2000). The IRS recently announced that the dollar limit under IRC §415(c)(1)(A) is increased from $30,000 to $35,000, effective January 1, 2001. Increases in the §415(c)(1)(A) limit takes effect for limitation years that end after the effective date of the limit. See Treas. Reg. §1.415-6(a)(2). Thus, a plan with a limitation year ending January 31, will use the $35,000 limit for the year ending January 31, 2001. Remember, the annual additions limit under §415(c) is the lesser of 25% of compensation or the applicable dollar limit. For years ending after January 1, 2001, employees with compensation in excess of $140,000, will be limited by the $35,000 limit and employees with compensation of $140,000 or less are limited by the 25% of compensation limit.

New SPD regulations require information about ERISA section 404(c), QDROs, plan termination (added (November 28, 2000). The DOL has amended the summary plan description (SPD) regulations to require the following items to be addressed in the SPD: 1) identification of the plan as an ERISA section 404(c) plan, if applicable, 2) inclusion of the plan's procedures for qualified domestic relations orders (QDROs) or a statement of the participant's right to request a copy of the plan's QDRO procedures free of charge, 3) an explanation of the plan sponsor's right to terminate the plan and the effect of termination on the participant's rights and obligations under the plan, and 4) updated information on PBGC coverage (defined benefit plans only). The amended regulations also provide an updated ERISA rights statement which must be included in the SPD or in a separate document provided in conjunction with the SPD. Additional changes are made for welfare benefit plans, particularly group health plans, to reflect COBRA and HIPAA requirements. The regulations are generally effective January 20, 2001, but SPDs are not required to reflect the new regulatory requirements until the second plan year which begins after January 20, 2001 (e.g., the 2003 plan year for a plan with a plan year that begins every January 1). The citation for the regulations is DOL Reg. §2520.102-3, paragraphs (d), (j), (l), (m)(3), (m)(4), (o), (q), (s), (t)(2) and (u), and removal of DOL Reg. §2520.102-5, 65 F.R. 70226 (November 21, 2000). With the delayed effective date, most employers will be able to conform their SPDs to the new regulations at the same time they are reflecting GUST amendments that will be adopted by most plans during 2001 or 2002.

Amended claims procedures regulations impose accelerated deadlines for group health plans and disability benefit claims (added November 28, 2000). The DOL has revised the ERISA claims procedures that are set forth in Reg. §2560.503-1 (65 F.R. 70246 (November 21, 2000)). The amended regulations apply to claims filed on or after January 1, 2002. For most pensions plans and welfare plans, the current time frames for processing claims remain, with minor modifications. More dramatic changes are adopted for group health plans and plans which offer disability benefits. These time-frames can be found in paragraphs (c), (d) and (f) of §2560.503-1. A plan must make a determination on a claim within a reasonable period after receipt of the claim, but not later than 90 days after receipt of the claim (same as prior regulations). However, for group health plans the maximum 90-day period is reduced to 72 hours for urgent care, 15 days for pre-service claims for non-urgent care (i.e., claims relating to benefits that must, in whole or in part, be pre-approved before medical care can be received), and 30 days for post-service claims for non-urgent care (i.e., claims that are not pre-service claims). For plans (including pension plans) that offer disability benefits, the maximum 90-day period is reduced to 45 days if the claim involves disability benefits. Note that with all of these time-frames, the maximum periods are not safe harbors. In all cases, the plan must act within a reasonable period of time, taking into account the applicable circumstances, but in no event later than the applicable maximum time-frame. For claims for urgent care and pre-service claims for non-urgent care, notice to the claimant is required within the applicable time frame regardless of whether the decision is adverse. For other claims, notice is required only for adverse decisions. The amended regulations also modify rules for extending these determination periods. Review of adverse determinations are also subject to shortened time frames for urgent medical care, pre-service claims for non-urgent medical care, and disability claims. Notifications to claimants may be provided in a written or electronic means. Electronic transmission must satisfy the requirements in DOL Reg. §2520.104b-1(c)(1)(i), (iii), and (iv).

Final rules subject certain small plans to an annual audit requirement in plan years beginning after April 17, 2001 (added October 21, 2000). The DOL has issued DOL Reg. §2520.104-41(c) and §2520.104-46(b)(1) and (d), published at 65 F.R. 62958, on October 19, 2000. Presently, DOL Reg. §2520.104-46 automatically exempts all small plans from the annual audit requirement (i.e., engaging an independent qualified public accountant to examine the financial statements of the plan and to issue a report to be attached to the Form 5500). A "small plan" is a plan that has fewer than 100 participants at the beginning of the plan year (or has 100-120 participants, but is electing to be treated as a small plan, pursuant to DOL Reg. §2520.103-1(d)). These regulations require small employee pension benefit plans (i.e., small deferred compensation plans, such as profit sharing plans, 401(k) plans, money purchase plans, defined benefit plans) to meet certain conditions in order to be exempt from the audit requirement. Those plans that cannot meet these conditions will have to engage an accountant to audit the plan, attach the accountant's report to the plan's Form 5500, and include the financial statements, notes and schedules that would apply to a large plan.

Effective date. The new audit waiver conditions are effective for plan years which begin after April 17, 2001 (i.e., more than 180 days after the publication date of the regulations). Thus, a plan which reports on a calendar year basis is not be subject to this rule until the plan year beginning January 1, 2002. On the other hand, a plan with an April 30 year end, is first subject to this rule for the plan year beginning May 1, 2001. The Form 5500 filed for the first plan year that this regulation is effective is the first filing that will need the audit report if the audit waiver conditions are not satisfied. Small welfare benefit plans are not be subject to these new rules, and continue to be exempt from the audit requirement, without condition.

¶1. Conditions for exemption from audit requirement. To be exempt from the audit requirement, a small pension benefit plan must satisfy both of the following requirements.

• 1) Investment/bonding requirement. At least 95% of the plan's assets must be invested in qualifying plan assets OR, if the 95% requirement is not satisfied, the assets that are not qualifying plan assets must be covered by a bond which meets the requirements of ERISA §412 and which is not less than the value of such assets. See ¶2 below for more details.
• 2) Disclosure requirement. The summary annual report (SAR) would have to include: a) information about the name of each institution holding qualifying plan assets and the amount of such assets held by such institution as of the end of the plan year, b) information about the surety company issuing a bond described in paragraph 1) (if applicable), c) a notice that the participants and beneficiaries may request to examine or receive a copy without charge of any bond required under paragraph 1) and of statements received from each institution holding qualifying plan assets which describe the assets held by the institution as of the end of the plan year, and d) a notice that the participants and beneficiaries should contact the DOL's Pension and Welfare Benefits Administration if they are unable to examine or obtain copies of these items. If a request described in c) is received, the plan administrator must provide the requested documents, or the exemption from the audit requirement would not be applicable.

  The disclosure information in a) would not apply to investments in qualifying employer securities, participants loans, and participant-directed investments, as described in 1), 2) and 6) of ¶2. below.

¶2. Qualifying plan assets. Qualifying plan assets are any of the following types of investments.

• 1) Qualifying employer securities.
• 2) Participant loans which meet the prohibited transaction exemption requirements under ERISA §408(b)(1). Note that the fact a loan exceeds the limits under §72(p) does not necessarily render the loan a nonqualifying asset. However, if the plan's loan policy expressly limits loans to the §72(p) limits, and the loan exceeds those limits, the loan has failed to follow the terms of the plan and, thus, is not exempt under ERISA §408(b)(1). The DOL addresses this issue in the preamble to the regulations. The preamble also notes that a loan that has gone into default is a qualifying plan asset, so long as it satisfy the prohibited transaction exemption requirements at the time it was made.
• 3) Assets held by a regulated financial institution.
• 4) Shares issued by an investment company registered under the Investment Company Act of 1940 (i.e., registered mutual fund).
• 5) Investments and annuity contracts issued by an insurance company qualified to do business under the laws of any state.
• 6) Assets in the individual account of a participant beneficiary over which the participant or beneficiary has the opportunity to exercise control and with respect to which the participant or beneficiary is furnished, at least annually, a statement from a regulated financial institution describing the assets held (or issued by) such institution. Note, as discussed in ¶1 above, the disclosures in the SAR would not have to include the assets described in this paragraph 6). Thus, a participant is not required to receive information in the SAR about the assets held in the individually-directed accounts of other participants.

Regulated financial institutions. For purposes of 3) above, a regulated financial institution is a bank, as defined in IRC §581, a domestic building and loan association, as defined in IRC §7701(a)(19), a credit union, as defined in section 101(6) of the Federal Credit Union Act), an insurance company, a registered broker-dealer, or any other organization that is authorized to act as a trustee of IRAs under IRC §408(a)(2) (see Treas. Reg. §1.408-2(e)).

"Held by" a financial institution. Assets are held by a regulated financial institution is they are held by the institution in a trust, custodial account, brokerage account, or in any type of omnibus account structure.

Mutual fund and insurance investments need not be held by financial institution. The final regulations added categories 4) and 5) above to clarify that shares in a mutual fund, and annuity contracts and other investment products issued by an insurance company, satisfy the definition of qualifying plan assets, even if there is no regulated financial institution to hold these investments. This was needed because under ERISA, the plan asset is the mutual fund shares or the annuity contract, not the underlying assets of those investments, so the mutual fund company or insurance company would not necessarily be holding the plan asset. Thus, if a small employer's plan is self-trusteed (e.g., an officer of the company is the named trustee), and does not use an institutional custodian, plan investments in mutual funds that are held in the name of the trustee, in insurance contracts owned by the individual trustee, are qualifying plan assets.

Determination of the percentage of qualifying plan assets. The determination of the percentage of assets that constitute qualifying plan assets is made at the beginning of the plan year, based on the information as of the last day of the preceding plan year, in accordance with the bonding regulations. See DOL Reg. §2580.412-14. For the first plan year, the determination is made on the basis of an estimate, as described in DOL Reg. §2580.412-15.

Normal bonding might be sufficient. Even if a small plan is subject to the special bonding requirement because more than 5% of its assets are not in qualifying plan assets, an additional bond might not be necessary. The normal requirement is that the value of the bond be at least 10% of the plan's assets (or $500,000, if less) being "handled" (within the meaning of ERISA §412). If a plan has a bond which covers the persons handling the nonqualifying assets, and that bond is for an amount no less than the value of the nonqualifying assets, then this audit exemption requirement is still satisfied. Thus, in many cases the audit exemption conditions will not result in a greater bonding requirement unless the nonqualifying assets exceed 10% of plan assets.

New comparability plans survive, but new proposed regulations will narrow the maximum disparity of allocations in favor of highly compensated employees starting in 2002 plan year (added October 5, 2000). As anticipated, the Treasury today issued proposed regulations regarding new comparability plans. The proposed effective date is plan years beginning on or after January 1, 2002. This would be a uniform effective date that would apply to all new comparability plans, regardless of whether the plan was in existence when IRS announced its review of new comparability plans (Notice 2000-14) or was adopted after that date. Before reviewing the discussion of the regulations below, keep in mind that if this effective date sticks in the final regulations (which it likely will), nothing changes in the way new comparability plans show they are nondiscriminatory for the 2000 and 2001 plan years. The proposal regulations would amend Treas. Reg. §§1.401(a)(4)-8(b)(1), 1.401(a)(4)-9(b)(2) and 1.401(a)(4)-9(c)(3).

What do the regulations do? They establish a "gateway" rule for defined contribution (DC) plans to prove allocations are nondiscriminatory on the basis of benefits. (New comparability is simply a phrase used to refer to DC plans that do this.) In other words, before the plan can be tested on the basis of benefits (i.e., converting allocations to equivalent benefit rates (EBRs) and applying the rate group test under Treas. Reg. §1.401(a)(4)-2(c) using those EBRs), the "gateway" test must be satisfied first. The gateway establishes a minimum contribution rate that must apply to the nonhighly compensated employees (NHCs). However, certain DC plans are exempt from the gateway test by establishing that the allocation rates are "broadly available" (as defined in the regulations). So let's get to specifics.

¶1. The "gateway" test. Under the "gateway" test, the lowest permissible allocation rate for any NHC who benefits under the plan is one-third of the highest allocation rate for any highly compensated employee (HCE). However, if each NHC receives an allocation that is no less than 5% of compensation (as defined under IRC §415(c)(3)), the gateway is deemed satisfied. Note that there is a different compensation rule for the one-third test than for the 5% test. The one-third test is based on the allocation rate. An employee's allocation rate is the percentage obtained by dividing the employee's allocation for the plan year derived from employer contributions (other than matching contributions, if the plan also includes a 401(k) arrangement) and forfeitures, divided by his plan year compensation. See Treas. Reg. §1.401(a)(4)-2(c)(2). Plan year compensation, in turn, is defined in Treas. Reg. §1.401(a)(4)-12 as compensation determined under IRC §414(s) (generally measured for the plan year, or the portion of the plan year that the employee is eligible for the plan). The 5% test, which is a safe harbor for meeting the gateway, is based on §415(c)(3) compensation, which is the same definition used to determine top heavy minimum contributions. If the plan determines allocation rates on the basis of §415(c)(3) compensation, then the gateway is simply satisfied if each NHC's allocation rate is at least 5% (or one-third of the highest HCE allocation rate, if that highest rate is less than 15%). Where the highest HCE allocation rate is 15% or greater, a 5% allocation rate will always satisfy the gateway because the definition of compensation being used to calculate allocation rates is the same definition as the Treasury uses to calculate the 5% safe harbor. However, if the plan determines allocation rates on the basis of a definition of compensation which satisfies §414(s), but does not satisfy §415(c)(3), it is possible that the one-third test may result in a minimum NHC allocation under the gateway that is less than 5% of §415(c)(3) compensation, even though the percentage under the one-third test is greater than 5%. For example, suppose the plan uses "net" compensation to determine allocation rates, meaning §415(c)(3) compensation reduced by the amount of elective deferrals (e.g., 401(k) deferrals, cafeteria plan deferrals), which satisfies §414(s), and the highest allocation rate of any HCE using this definition is 16%. The one-third test is satisfied if each NHC has an allocation rate (using the same definition of compensation) is at least 5.33%. Therefore, if no NHC has an allocation rate less than 5.33%, the gateway is satisfied, even though some of the NHCs might have an allocation that is less than 5% of §415(c)(3) compensation.

• Analyze a plan's historical data. For your currently effective new comparability plans, look to see what the lowest contribution rate has been for the NHCs. If it is at least 5%, this regulation would not change a thing (unless the plan defines compensation different from the §415(c)(3) definition, so that a 5% allocation under the plan might not be sufficient to meet the gateway). If it is less than 5%, the employer will need to be prepared to raise the contribution rate for some of its NHCs if the lowest rate otherwise would be less than the applicable gateway percentage.
• Example. A new comparability plan provides for two allocation groups: Group A consists of owners of the company, who are all HCEs, and Group B consists of other eligible employees. The employer makes a discretionary contribution for each group. The amount contributed for the benefit of each group is allocated to the eligible employees included in that group, using a pro rata allocation formula based on §415(c)(3) compensation. For the last several years, the contribution rate for Group A has been in the range of 14% to 20%, and the contribution rate for Group B has been in the range of 6% to 8%. The plan passes the rate group test on the basis of equivalent benefit rates (EBRs). The proposed regulations would not affect this plan, so long as the contribution rate for Group B does not drop below 5%. Of course the plan would still have to show that the rate group test can be passed on the basis of EBRs on a plan year by plan year basis.
• Example. Assume in the prior example that the plan has been passing the rate group test (using EBRs) by only contributing 3% for Group B. Under the proposed regulations, if the employer did not want to increase the contribution rate for Group B above 3%, it would have to limit the contribution rate for Group A to 9% (so the one-third test can be satisfied under the gateway test), even if the plan's EBRs could pass the rate group test if the contribution rate were greater than 9%. If the plan does not meet the gateway test, then the plan could not use EBRs to pass the rate group test.

¶2. Broadly available allocation rates. The proposed regulations would not require a plan to pass the gateway test described in ¶1. above, so long as each allocation rate can meet a "broadly available" test. The broadly available test essentially treats each allocation rate in a manner similar to the way "benefits, rights or features" (BRFs) are treated under Treas. Reg. §1.401(a)(4)-4. That regulation requires that each BRF under the plan is available to a group of employees who, if they were treated as participating in a separate plan, could satisfy the nondiscriminatory classification test under Treas. Reg. §1.410(b)-4. The nondiscriminatory classification test is the first part of the average benefits test under the minimum coverage requirements. The coverage ratio needed to pass the nondiscriminatory classification depends on the percentage of employees that are NHCs and is within a range of 20% to 50%. For more details on the nondiscriminatory classification test, see Chapter 8, Section V, Part B., of The ERISA Outline Book.

• Disregarding age and service conditions. When determining whether an allocation rate is available to an employee, age or service conditions may be disregarded, but only if the plan uses an allocation formula that applies to all employees who benefit under the plan, and which provides a single schedule of rates that are based solely on age OR service (but not both age and service), and only if allocation rates increase smoothly at regular intervals.
• Regular intervals. To determine if age-based or service-based allocation groups are determined in regular intervals, there would have to be uniform age brackets or service brackets (excluding the highest bracket). Furthermore, if the brackets are based on age, and the first bracket ends at an age younger than 25, the length of the first bracket is deemed to be the same as the others. For example, if the plan provides separate allocation rates based on age, the first bracket being participants under age 25, with subsequent brackets in 5-year groups (e.g., ages 25-29, ages 30-34, ages 35-39, etc.), and the highest bracket age 65 and older, the allocation formula would satisfy the regular interval requirement.
• Smooth increases. The allocation method would have smooth increases if two tests are satisfied: 1) the allocation rate for each age band or service band is greater than the allocation rate for the prior age band or service band, but by no more than 5 percentage points, and 2) the ratio of the allocation rate for an age band or service band to the allocation rate for the previous age band or service band is not more than 2.0 or, if less, the ratio of the allocation rates for the two preceding bands. To illustrate, suppose the allocation formula provides for age bands based on 5-year increments, as described in the prior paragraph. Suppose for the 2002 plan year that the allocation rate for the lowest age band is 2% and the allocation rate for the 25-29 age band is 3%. That means the ratio of the 25-29 age band's rate (3%) to the ratio of the under 25 age band's rate (2%) is 1.5. Since that ratio is no more than 2.0 ratio, the smooth increase test is passed so far. To pass the smooth increase test with respect to the next age based (30-34), the allocation rate could not exceed 4.5%, because that produces a 1.5 ratio when compared to the allocation rate for the 25-29 age band (4.5%/3%), and the ratio cannot exceed the ratio for the prior two age bands (which was 1.5). All of the age bands would have to meet this test in order for the plan to be able to disregard the age condition when applying the broadly available test.
• What if the "regular intervals" and "smooth increases" tests are not satisfied? All that means is that the age conditions or service conditions used to determine the allocation groups cannot be ignored when determining whether those allocation groups pass the nondiscriminatory classification test. If, as a result, not all of the allocation groups could pass the nondiscriminatory classification test, the plan would have to satisfy the gateway test in order to use EBRs to show that the rate group test is satisfied.

¶3. What's the practical implication of the broadly available allocation rates option? The Treasury's primary motivation in proposing these rules was to address the fact that NHCs are often not able to "grow into" the higher allocation rates available under a new comparability plan. Take the plan described in the examples under ¶1 above. In that plan, the higher allocation rates are provided only to owners, who are the eligible employees included in Group A. A non-owner, which includes any of the NHCs eligible for the plan, would not move into Group A, regardless of his age or how long he works for the company. In addition, Group A does not consist of a group of employees that could pass the nondiscriminatory classification test because 0% of the NHCs have the Group A contribution rate available to them. Therefore, this plan, starting in the 2002 plan year, will have to satisfy the gateway test in order to continue using EBRs to test under §401(a)(4).

What type of plan design might meet the broadly available test? Consider the following example. BMI Corporation has three allocation groups. Each group covers a different division. For each plan year, a different contribution rate is made for each division based on its profitability. For the 2002 plan year, Division A's group gets a 20% allocation rate, Division B's group gets a 7% allocation rate and Division C's group gets a 3% allocation rate. Assume there are HCEs and NHCs in each group. The gateway test is not satisfied because the NHCs in the Division C group have an allocation rate which is less than one-third of the allocation rate received by the HCEs in the Division A group, and they have not received an allocation equal to at least 5% of 415(c)(3) compensation. But suppose that each division passes the nondiscriminatory classification test. Thus, the 20%, 7% and 3% allocation rates are broadly available, and the plan would not have to pass the gateway test in order to be tested on the basis of EBRs.

Another example would be age-weighted plans. These plans are designed to make allocation strictly based on age, providing a higher allocation rate as the participant gets older to take into account that each year's contribution will be accumulated over a shorter period of time to normal retirement age because of the participant's advancing age. Generally, unless the 415 limits result in a lower allocation, or the top heavy minimum contribution rules result in a greater allocation, the age-based allocation method will produce identical EBRs for each eligible participant. Age-weighted plans generally will satisfy the standards for disregarding age conditions, which is the sole reason why employees receive different allocation rates under the age-weighted formula. Thus, these plans will be able to ignore the gateway test under the proposed regulations because all participants would be deemed to have the highest allocation rate available to them. Thus, the age-weighted plan would still be able to use EBRs to pass §401(a)(4), even if some of the NHCs receive a lower contribution rate than would be required under the gateway test.

¶4. Safe harbor 401(k) plans. Sometimes the employer maintains a safe harbor 401(k) plan in addition to (or as part of) a new comparability profit sharing plan. If the profit sharing contributions are tested on the basis of EBRs, and the gateway test has to be satisfied, the safe harbor nonelective contribution under the safe harbor 401(k) rules, as described in IRC §401(k)(12)(C), is permitted to be included in the determination of whether the gateway test is satisfied. For example, suppose an employer maintains a new comparability plan with a safe harbor 401(k) arrangement. To satisfy the 401(k) safe harbor, the employer provides the 3% safe harbor nonelective contribution. In addition, a discretionary profit sharing plan is provided using the plan design described in the examples in ¶1 (Group A consists of owners, Group B consists of all other eligible employees). The 3% safe harbor nonelective contribution may be counted in determining whether the Group B employees satisfy the gateway test. Thus, if the gateway test requires NHCs to have at least a 5% allocation, and all the Group B employees are eligible for the 3% safe harbor nonelective contribution, then their allocation from the discretionary contribution would only have to equal at least 2% of compensation.

¶5 DB/DC combinations. In some cases an employer maintains both a defined benefit plan and a defined contribution plan. Under these proposed regulations, if those plans are permissively aggregated in order to pass coverage and nondiscrimination testing (known as a DB/DC plan), and the nondiscrimination test is run on the basis of benefits (i.e., normal accrual rates under the DB plan plus EBRs under the DC plan), additional conditions would be imposed starting in the 2002 plan year. What are these additional conditions? The DB/DC plan would have to meet a special gateway test, on an allocations basis, unless: 1) the DB/DC plan is "primarily defined benefit", OR 2) the DC component and DB component of the aggregated DB/DC plan are broadly available if tested separately. A DB/DC plan would be treated as primarily defined benefit if 50% or more of the NHCs benefiting under the plan have a normal accrual rate under the DB plan that exceeds their EBRs under the DC plan. The special gateway test that would apply if the DB/DC plan could not satisfy 1) or 2) would require that each NHC's combined allocation rate (i.e., the sum of the NHC's allocation rate under the DC plan and the NHC's equivalent allocation rate under the DB plan) could not be less than 5%, if the highest combined allocation rate for any HCE is 25% or less. If the highest HCE combined allocation rate is more than 25%, the minimum combined allocation rate for the NHCs would be 5% plus 1% point for each 5% points (or portion thereof) that the highest HCE rate exceeds 25% (e.g., 6% if the highest HCE rate is more than 25% but not more 30%). If one of these tests could not be satisfied, the DB/DC plan would not be permitted to test on the basis of benefits. In other words, it would have to test on the basis of contributions. If the DB plan is tested separately from the DC plan (i.e., there is no DB/DC plan for testing purposes), the requirements in this ¶5 would not apply.

¶6. Review regulations and your plan designs now. Now is the time to review the regulations and determine how they will affect the plan designs of your clients (or your own plan, if you're also a plan sponsor of a new comparability plan). Assess whether contributions will need to increase for the NHCs (or some of the NHCs) in order to keep the HCEs at present levels. This is also the time to determine whether the proposed regulations are inadvertently disrupting legitimate plan designs that the Treasury did not intend to subject to the gateway test. If you identify any such situations, let the Treasury know. The sooner the better. These proposed regulations are probably on a "fast track" for finalization.

Update of IRS procedures for automatic approvals in funding method changes (added October 2, 2000). The IRS has published Revenue Procedure 2000-40, which updates its procedures for automatic approvals of certain changes in funding methods under defined benefit plans. The new procedure supersedes Revenue Procedures 95-51, 98-10, and 99-45, and is effective for plan years commencing on or after January 1, 2000. Section 3 of the procedure prescribes 17 different approvals for various funding method changes. Section 4 prescribes special approvals relating to: 1) remedy of unreasonable allocation of costs, 2) fully funded terminated plans, 3) takeover plans, 4) changes in valuation software, 5) de minimis mergers, and 6) other mergers. Restrictions prescribed in section 6 of the procedure must be satisfied in order to rely on automatic approval granted by the procedure. Normally changes in the funding method require approval from the IRS, pursuant to IRC section 412(c)(5). The purpose of procedures like Revenue Procedure 2000-40 is to grant approval for certain changes that eliminate the need to apply to the IRS for permission.

Cash balance plan created an impermissible forfeiture when it used a lower interest rate than the plan's floor interest rate to project cash balance account for purposes of determining the present value of accrued benefits (added October 2, 2000). [Citation: Esden v. Bank of Boston, No. 99-7210 (2nd Cir. September 12, 2000), reversing In re Esden, 22 EBC 1834 (D.Vt. September 28, 1998)] The court in this case upholds the IRS' interpretation of how IRC section 417(e) applies to cash balance plans, as set forth in Notice 96-8. Esden, a participant in the plan, requested a lump sum payout following her termination of employment. The plan provides the following methodology for calculating an immediate lump sum. (1) Step one. The current balance of the Cash Balance Account is projected to normal retirement age using a 4% assumption, regardless of the interest rate currently in effect under the plan to determine annual interest credits to the cash balance accounts (which has a 5.5% floor under the terms of the plan). (2) Step two. The projected balance determined in step one is then converted to the actuarial equivalent of an annuity using the actuarial assumptions specified under the plan. (3) Step three. The actuarially equivalent annuity determined in step two is discounted to present value at an interest rate prescribed by IRC §417(e). (Note that the plan had not yet adopted the GATT amendments to §417(e), so the PBGC rates, rather than the 30-year Treasury rates, were used to determine the maximum interest rate under §417(e) for the present value determination.) The lump sum payout is then the greater of the current cash balance account or the present value calculated under the above methodology. Anytime the projected interest rate (step one of the calculation) is greater than the discounting rate used under §417(e) (step three of the calculation), the present value calculation will yield a greater lump sum that a participant's cash balance account. This is commonly referred to as the "whipsaw" effect. Esden argued that the plan's floor interest rate of 5.5%, which is used to make interest adjustments to cash balance accounts until distribution is actually taken, represents a minimum interest rate that must be used to project future interest credits to the cash balance account under step one of the above calculation. If the plan had used the 5.5% assumption, Esden would have received a payment in excess of her current cash balance account. The plan had paid her only her cash balance account.

• Statutory framework.The court's opinion provides a good analysis of the statutory framework for calculating accrued benefits under defined benefit plans and the requirement for optional forms of benefit to be the actuarial equivalent of the accrued benefit. Many of the issues that arise with cash balance plans are a result of the fact that the much of the governing statutory language was written with a traditional defined benefit plan in mind. IRC §411(a)(7)(A)(i) and ERISA §3(23)(A) define a participant's accrued benefit under a defined benefit plan as the accrued benefit determined under the plan, expressed in the form of an annual benefit commencing at normal retirement age. In addition, IRC §411(c)(3) and ERISA §204(c)(3) require that, if a participant's accrued benefit is to be determined as an amount other than an annual benefit commencing at normal retirement age, it must be the actuarial equivalent of the accrued benefit. Because of this statutory framework, a cash balance plan, since it is a defined benefit plan, must convert the cash balance account to an annuity payable at normal retirement age before it can determine whether any optional forms of benefit are at least the actuarial equivalent of the accrued benefit. Hence, the reason for steps one and two of the present value calculation described above, before the participant's lump sum payment can be determined under step three. If the plan simply pays the cash balance account, or sets the projected interest rate artificially low so that the cash balance account is always greater than the step three amount, the statutory framework is not always satisfied.
• IRS guidance on the subject.In Notice 96-8, the IRS provides that if a cash balance plan projects the cash balance account forward at a rate less than the interest credits under the plan, a forfeiture of a portion of the participant's accrued benefit results, in violation of IRC §411(a)(2) and ERISA §203(a)(2). The court concludes that the plan's use of 4% interest rate, rather than at least the plan's floor rate of 5.5%, worked such a forfeiture against Esden's accrued benefit. It forced Esden to accept a lower interest rate than she would have earned on her cash balance account simply because she elected a lump sum option from the plan. In the court's view, Notice 96-8 represents a fair and considered judgment by the IRS of how the existing regulatory scheme should work, and is entitled to deference. The court also believes that the application of Notice 96-8 does not raise a problem of retroactivity, even though it was published in 1996 and Esden's distribution occurred in 1991, because there was an existing regulatory framework under Treas. Reg. §1.401(a)(4)-8(c)(3), which raised the same issues regarding the projection of interest rates. Notice 96-8 simply interpreted that regulation. (The court doesn't address the fact that the Treasury regulation applies only to a safe harbor test for nondiscrimination testing purposes, and that the regulation does not suggest that it is the sole means of interpreting the law with respect to cash balance plans.)
• Duty not to follow the terms of the plan. This is a case where ERISA §404(a)(1)(D) trumps the plan document. The employer argued that since the plan provided for the 4% interest rate projection when a terminated participant elected to receive distribution before normal retirement age, that Esden's lump sum was determined consistent with the terms of the plan. The court noted, however, that §404(a)(1)(D) requires a fiduciary to follow the governing plan documents only if those documents are not contrary to ERISA. The method used to calculate Esden's lump sum was in violation of the minimum vesting standards under ERISA.

Determination of whether partial termination occurs is based on the percentage of all participants terminated by the company (vested and non-vested) and may involve terminations spanning over more than one plan year (added October 2, 2000). [Citation: Matz v. Household International Tax Reduction Investment Plan, No. 00-1109 (7th Cir. September 21, 2000)] This case addresses two important questions with respect to whether a partial termination has occurred under a plan. (1) Are both vested and non-vested participants taken into account to determine if a significant percentage of participants have been eliminated from the plan? (2) Can a single partial termination transaction occur over more than one plan year? The court answers yes to both questions.

• Summary of facts. Household International, Inc. ("Household") was the parent corporation of a varied group of corporations. Starting in August of 1994, Household began selling off some of its subsidiaries, beginning with Hamilton Investments, Inc., which is the company the plaintiff (Matz) worked for. When Matz was terminated, he was only 60% vested in his account derived from employer contributions (the plan provided for a 5-year graded vesting schedule). For the period starting August 1994 and ending May 1996, Household not only sold Hamilton Investments, but also several branches of another subsidiary, and all of a third subsidiary. Matz claimed that those sales were part of a single reorganization plan, and, when looked at together, resulted in a partial termination. Household countered by arguing that each plan year must stand alone, looking only at terminations in that plan year, to determine if a partial termination has occurred. Household also argued that only non-vested participants should be taken into account to determine if a partial termination occurred, regardless of the period over which terminations are analyzed.
• Counting of vested and non-vested participants. Since neither the statute nor the legislative history offers a clear standard of how to calculate a significant reduction of plan participants, the court first turned to the opinions of two other courts. In Weil v. Retirement Plan Administrative Committee, 933 F.2d 106 (2nd Cir. 1991), the court ruled that both vested and non-vested participants were counted. Thus, the ratio of terminated participants to all participants was calculated to determine if there had been a significant reduction in the percentage of plan participants. This is also the view held by the IRS. In In re Gulf Pension Litigation, 764 F.Supp. 1149 (S.D.Tex. 1991), the court fashioned a different approach, excluding the vested participants from both the numerator and the denominator of the ratio. Thus, the significance of the reduction of plan participants was based solely on the percentage of non-vested participants who were terminated by the employer. The 7th Circuit opts for the reasoning in Weil, since neither the statute (IRC §411(d)(3)), its legislative history, nor the Treasury regulation (§1.411(d)-2(b)), differentiates between vested and non-vested participants.
• Aggregation of multiple plan years. The court held that since there is nothing in the language of the partial termination rule itself that requires a significant corporate event to occur within a plan year, the plaintiff is allowed to combine terminations from 1994, 1995, and 1996. However, in order to combine those terminations, the plaintiff must show that the corporate events for those years were related. To adopt a rigid rule that treats each plan year separately would enable an unscrupulous employer to avoid a partial termination by terminating some participants in the last month of one plan year and other participants in the first month of the next plan year, even though the terminations relate to the same layoff event.

Treasury gives green light on eliminating periodic payment options in defined contribution plans, relaxes elective transfer rules, and permits elimination of certain in-kind distributions under defined contribution plans(added September 1, 2000). The Treasury has finalized amendments to Treas. Reg. §1.411(d)-4 that relax some of the requirements under IRC §411(d)(6) to protect optional forms of benefit. Unlike many proposed regulations, the proposal that preceded the issuance of these regulations could NOT be relied upon. So the publication of these final regulations (in record time - less than 6 months!) now provides a green light to implement the flexibility afforded through these regulations. The regulations are effective September 6, 2000, which means amendments adopted AND effective on or after September 6, 2000, may implement the regulations. Note, however, in the discussion below on the elective transfer rules, that after December 31, 2001, the elective transfer option for distributable benefits will be available only when the direct rollover option is not available to move the participant's entire vested benefit to the transferee plan (i.e., if a single-sum distribution is not available to the participant or if the vested benefit includes after-tax dollars that would not be eligible for rollover). The regulations allow: 1) defined contribution plans to eliminate all periodic payment options (e.g., annuities or installment distributions), except to the extent the qualified joint and survivor (QJSA) rules under IRC §401(a)(11) require the plan to offer at least the QJSA option (i.e., money purchase plans, target benefit plans, as well as profit sharing plans that fail to satisfy the exemption requirements under IRC §401(a)(11)(B)(iii)), 2) defined contribution plans to eliminate certain in-kind distribution options, 3) defined benefit plans or defined contribution plans to replace the right to take an annuity distribution in the form of an annuity contract with the payment of that annuity in cash, and 4) relax the elective transfer rules. Here are some highlights.

• Elimination of QJSA in non-pension plan. A non-pension plan (e.g., profit sharing plan) that currently offers life annuity options and, thus, must comply with the qualified joint and survivor annuity requirements (QJSA) under IRC §417, is able to eliminate the QJSA by discontinuing annuity options, so long as a single-sum distribution is available on identical terms after the amendment (i.e., the single sum must be available as of the date time as the annuity option could have commenced). These rules do not override the QJSA rules for plans which are required by statute to comply with them. For example, a pension plan (e.g., money purchase plan) could not be amended to eliminate the QJSA (but could eliminate other periodic payment options which are not required by the QJSA rules, such as an installment distribution option). Also, a non-pension plan which is a transferee of a money purchase plan, as described in IRC §401(a)(11)(B)(iii)(III), would not be permitted to eliminate the QJSA option, at least with respect to the transferred benefits. But, a profit sharing plan or stock bonus plan, including a 401(k) plan, which originally was drafted with QJSA provisions but otherwise is not required to provide the QJSA option except for the fact that §411(d)(6) protected the option before the issuance of these regulations, can now be amended to eliminate the annuity option altogether.
• Reduction of all periodic payment options is possible. Unlike the proposed version of these regulations, the final regulations allow all periodic payment options to be eliminated. Therefore, a profit sharing plan that currently offers both installment distribution options and single-sum distribution options could be amended to limit all distributions to single-sum distributions. If the plan also offered life annuity options in addition to the installment options, both the annuity and installment options could be eliminated. The single-sum distribution option must be available at the same time as the periodic payment options could have commenced. For example, if the plan allows for annuity payments or installment payments commencing as soon as administratively feasible after a participant's termination of employment, the single-sum option which replaces the eliminated periodic payment options also must be available at the same time. Also, a plan that is required to have at least the QJSA option (see prior paragraph) could not eliminate that option under these regulations, but could eliminate all other periodic payment options.
• Delay on the effective date of the amendment. The Treasury is concerned, however, that a participant who may be near a distribution event under the plan, and who is planning to elect a periodic payment option available under the plan, should not be forced to accept a single-sum distribution because of an intervening amendment adopted before the participant's annuity starting date. To this end, the regulations provide that an amendment which eliminates a periodic payment option under a defined contribution plan may not be effective until the earlier of: 1) the date which is the 90th day following the date a summary of the amendment is furnished to the participant which satisfies the requirements under DOL Reg. §2520.104b-3 to furnish a summary of material modifications), or 2) the first day of the second plan year following the plan year in which the amendment is adopted. Any participant whose annuity starting date occurs before the delayed effective date must be allowed to elect the eliminated periodic payment option. To illustrate, suppose a profit sharing plan has a plan year ending December 31. On November 1, 2000, the plan is amended to eliminate its annuity options (and thus, the QJSA option). The first day of the second plan year following November 1, 2000, is January 1, 2002. A participant whose annuity starting date is before January 1, 2002, or, if earlier, before the 90th day following the furnishing of a summary of the amendment, would have to have the eliminated annuity option(s) available.
• Responds to changes in documents and business transactions involving change of plans. The right to eliminate periodic distribution options, as described above, responds to a need to have more flexibility when employees' benefits are transferred to another plan because of a business transaction (e.g., stock or asset purchase, or merger of companies), or when a plan document is amended from one prototype or volume submitter specimen plan to another, where the document providers of the respective plans may have offered very different periodic payment options.
• Elective transfers between DC plans of benefits that are not immediately distributable (business transaction or employment change transfers). The regulations allow a defined contribution plan to permit a participant to elect to have his benefit transferred to another defined contribution plan in an elective transfer transaction prior to the time his benefit is immediately distributable under the transferor plan, but only when the transfer is in connection with one of two types of events: 1) a business transaction, involving a sale of stock or assets, or a merger of companies or similar transaction, which results in a transfer of employment to another entity, or a change in employment classification that eliminates the employee's right to continue to actively participate in the transferor plan (i.e., the new job is not within the covered employment classes under the plan). If the transferor plan is a money purchase plan, 401(k) plan, or ESOP, the transferee plan must be the same type of plan. Also, there must be an opportunity to retain the participant's §411(d)(6) protected benefits (e.g., the right to leave the benefits under the transferor plan). This elective transfer option is available for transfers made on or after September 6, 2000 (even if the business transaction or employment change occurred before that date). Under these elective transfers, the transferee plan would not have to protect optional forms of benefit available under the transferor plan with respect to the transferred benefits (except as required by the QJSA requirements under IRC §401(a)(11) and IRC §417). This is a departure from current regulations, which allow elective transfers only when the benefits are immediately distributable. However, this type of elective transfer is available only under the restricted circumstances described in this paragraph. The regulations make clear that this type of elective transfer option is not a protected optional form of benefit, but rather is a "right or feature" under §1.401(a)(4)-4(e). In addition, when testing whether the right or feature is available on a nondiscriminatory basis, restrictions on the transfer option to just a specified business transaction, or the fact that the option applies only to business transactions or to employment status changes, are disregarded. Thus, the fact that a group of participants involved in a business transaction are disproportionately made up of highly compensated employees, and the elective transfer option was available only to those participants, would not result in a discrimination testing problem.
• Elective transfers of distributable benefits. For distributable benefits, the present requirements for elective transfers are somewhat relaxed by these regulations. Under current rules, if the participant's benefit was not distributable in a single sum form, there was some question whether the elective transfer was available. These regulations clarify that the elective transfer option is available even if the benefits are immediately distributable only in an annuity or installment form. The requirements to make a voluntary election (with spousal consent, if the QJSA rules apply) and that the participant's entire vested benefit must be transferred to the transferee plan is retained from current rules. However, on or after January 1, 2002,the elective transfer option for distributable benefits will be available only if the direct rollover option under IRC §401(a)(31) would not be available to transfer the participant's entire vested benefit to the transferee plan. This latter rule will limit this elective transfer option after 2001 to only two circumstances: 1) benefits distributable only in periodic payment forms (i.e., the plan does not have a single-sum distribution option available), and 2) benefits that include amounts which are not eligible for rollover (e.g., after-tax contributions or other amounts previously includible in income). Thus, if a participant elects a single-sum distribution after 2001, and that distribution consists entirely of amounts that are eligible for rollover, the only way to transfer to another qualified plan will be through the direct rollover process. This eliminates the duplication between the direct rollover rules and the elective transfer rules. However, if the entire benefit cannot be transferred through the direct rollover process the participant could be given the choice between: 1) an elective transfer of the entire vested benefit, or 2) a direct rollover of the portion which can be rolled over and an elective transfer of the rest. Elective transfers of distributable benefits eliminate all protected optional forms of benefit that were available under the transferor plan (even QJSA options), subject the transferred benefits only to those options available under the transferee plan. The final regulations retain the right to make elective transfers between defined contribution plans, between defined benefit plans, from a defined contribution plan to a defined benefit plan, or from a defined benefit plan to a defined contribution plan. However, if a defined benefit plan accepts an elective transfer from a defined contribution plan, it must provide a minimum benefit, expressed as an annuity payable at normal retirement age, that is derived solely on the basis of the transferred account balance. Also note that current rules required elective transfers of distributable benefits to be between plans maintained by the same employer (or within the employer's related group). These new regulations drop that restriction, so that these elective transfers could occur outside of the employer's related group (e.g., to the plan of a new employer the participant has gone to work for). The right to make an elective transfer of distributable benefits is a protected optional form of benefit under IRC §411(d)(6).
• Elimination of in-kind distributions in marketable securities. A defined contribution plan that permits employees to receive distributions in-kind (e.g., distributions of specific investments in a participant-directed account) may be amended on or after September 6, 2000, to require cash distributions to the extent the account balance is invested in marketable securities other than employer securities. Nonmarketable securities (e.g., limited partnership interest), employer securities, and other in-kind distribution options (e.g., real estate investments), could not be substituted with cash distribution options, but amendments could be adopted to restrict the availability of such in-kind investments and to eliminate the right to invest in such investments. See the next paragraph.
• Limitation of in-kind distributions to investments at time of distribution. A defined contribution plan that permits employees to receive in-kind distributions may be amended on or after September 6, 2000, to limit the available in-kind distributions to the investments held by the participant's account at the time distribution is elected. In addition, the right to the in-kind distribution for investments held at the time of distribution would only have to be protected to the extent such type of investment was in the participant's account when the amendment was adopted (or effective, if later). Such a rule would provide plans more flexibility to change investment options. For example, if a profit sharing plan allows distribution in the form of employer securities, but at the time of distribution, the participant's account does not have any investments in employer securities because the employer has discontinued the option to invest in employer securities, the plan would not have to offer the participant distribution in the form of employer securities.

Guidance on determination letter applications for volume submitter adopters of specimen plans that have not received GUST advisory letters (added August 28, 2000). Announcement 2000-77 clarifies which application form a volume submitter adopter must file when application for a GATT II letter is made. The guidance is a follow-up to Rev. Proc. 2000-27, which opens up the determination letter program to consider all amendments required by the pieces of legislation which collectively make up the acronym GUST. Under Rev. Proc. 2000-27, the IRS announced that it will review a volume submitter adopter's plan for a GUST II letter, which is a letter that considers all GUST changes, including those that become effective after December 31, 1998, even if the specimen plan does not have a GUST II advisory letter, unless the employer specifically requests a pre-GATT or GUST I letter. A pre-GATT letter is one that does not consider any of the GUST changes, and a GUST I letter is one that considers only the pre-1999 changes made by GUST. Since an adopter of a specimen plan that only has a pre-GATT or GUST I letter may require significant amendments and, in some cases a complete restatement, Form 5300 (rather than Form 5307) may need to be filed if the scope of review is for a GUST II letter.

• Specimen plan has a GUST I advisory letter. In this case, Form 5307 may be used unless the employer's plan is intended to be a safe harbor 401(k) plan, within the meaning of IRC §401(k)(12) and §401(m)(11), because the GUST I letter on the specimen plan would not have addressed these safe harbor provisions. If the plan is intended to satisfy the safe harbor 401(k) rules, the plan must be restated and a Form 5300 must be filed. In other words, the IRS is recognizing that among the post-1998 changes covered by a GUST II letter (e.g., §415(e) repeal, change in the eligible rollover distribution definition with respect to 401(k) hardship withdrawals), which would not have been addressed in the specimen plan's GUST I letter, only the safe harbor 401(k) rules require significant amendments.
• Specimen plan has a pre-GATT advisory letter. In this case, if the scope of the determination letter review is for a GUST II letter, Form 5300 generally must be submitted, because the advisory letter issued on the specimen plan did not consider any of the GUST amendments. However, if the plan is a defined contribution plan that provides only for nonelective employer contributions (i.e., a profit sharing plan that does not include a 401(k) arrangement, or a money purchase plan or target benefit plan), a restatement of the plan would not be required to amend for GUST. In such case, the necessary GUST amendments could be accomplished with a separate plan amendment, and Form 5307 could still be submitted to obtain the GUST II letter.

Bank's nonqualified plan offered to officers and managers satisfied criteria for top hat plan, even though participants represented 15% of workforce and a very small number were arguably not "select group" employees (added August 28, 2000). Demery v. Extebank Deferred Compensation Plan, 24 EBC 2095 (2nd Cir. June 15, 2000), offers a good explanation of the top hat plan definition, and provides helpful guidance on how the top hat criteria may be applied. Extebank offered a nonqualified deferred compensation plan to its assistance vice presidents, managers, and other senior officers. The eligible participants represented approximately 15% of the workforce. Some of the participants brought ERISA claims for additional benefits from the plan. The benefits being claimed by the plaintiffs would not be required under ERISA if the nonqualified plan satisfies the definition of a top hat plan. The plaintiffs claimed that the plan is not a top hat plan.

• Analysis of top hat plan issue. ERISA defines a top hat plan as a plan which is maintained by an employer "primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees." This definition appears in ERISA §201(2) (exemption from minimum participation, vesting and accrual standards), ERISA §301(a)(3) (exemption from minimum funding requirements), and ERISA §401(a)(1) (exemption from fiduciary standards). The plaintiffs argued that the plan is not a top hat plan because it is offered to 15.34% of employees, the participants were not all management or highly compensated employees, and the participants did not have the ability to effectively negotiate for themselves. The court concluded that the plan is a top hat plan. First, there is no existing authority that establishes when a plan is too large to be deemed "select." While admitting that 15.34% is probably "at or near the upper limit of the acceptable size" for a select group, the court would not conclude that the percentage alone is enough to make the plan too broad to be a top hat plan. Second, the average salary of the plan participants was more than double that of the average salary of all the bank's employees. This was evidence that the participants were highly compensated employees within the meaning of the ERISA top hat plan definition. Finally, the court found as significant that the statutory definition refers to the plan being primarily designed to provide deferred compensation to the select group, suggesting that a plan would not fail to be a top hat plan merely because a very small number of the participants did not meet the select group criteria. The court acknowledged that the bargaining power of the participants is an important factor, but did not find any evidence proffered by the plaintiffs that would suggest this criterion was lacking.

No affirmative duty to disclose information about benefit enhancements after amendment is under serious consideration, but employer, if it has agreed to follow up with an inquiring employee, must provide affirmative disclosure when the proposal later comes under serious consideration (added August 28, 2000). In Bins v. Exxon Co. USA, No. 98-55662 (9th Cir. August 10, 2000), the 9th Circuit addresses an employer's duties to disclose an planned enhancement to the company's employee benefit plan.

• Facts of the case. Bins retired on February 1, 1996. For a number of months he inquired about rumors regarding a benefit enhancement to be adopted by Exxon. He specifically asked his supervisors, the assigned benefits counselor, and one of the Exxon attorneys. He did not inquire again after December 27, 1995. The actual benefit enhancement was announced a few weeks after Bins' retirement date. He sued on the basis that the company had an affirmative duty to disclose the pending proposal to him and failure to do so resulted in his deciding to retire prior to the date he would have qualified for the enhanced benefit.
• Background on the legal issue. The scope of a fiduciary's duties relating to an employer's consideration of plan amendments has been a developing issue in case law. The leading case is Fischer v. Philadelphia Electric Co., 96 F.3d 1533 (3rd Cir. 1996) (often referred to as Fischer II, because it was the second of two cases with the same parties). Fischer II established the "serious consideration" test. That test provides for appropriate communication by the fiduciary once a potential change in benefits is under serious consideration by the company. The goal of the "serious consideration" test is for employees to learn of potential changes if the company's deliberations have reached a level when an employee should reasonably factor the potential change into an employment decision. Although the serious consideration test is the leading approach, the courts differ as to the scope of the fiduciary's communication responsibilities. The court's opinion provides a good review of the leading cases in this area. Most of the opinions accept the principle that the fiduciary must not affirmatively mislead or misrepresent a potential change in benefits that is under serious consideration. Furthermore, the courts have ruled that a fiduciary must disclose the change under serious consideration if questioned by a participant or beneficiary about whether a change is being considered. The fiduciary has an obligation to answer completely and truthfully about the present status of the proposed amendment - i.e., whether it is under serious consideration.
• What the court had to decide in this case. The 9th Circuit was asked by the plaintiff in this case to go a step further and hold that, once the proposal is under serious consideration, the fiduciary has an affirmative duty to disclose information about the proposal to all participants and beneficiaries to whom the employer knows, or has reason to know, that the information is material. In an opinion issued in August 1999 (reported at 23 EBC 1617), the court ruled that such an affirmative duty existed. However, that opinion was withdrawn, and a rehearing en banc was granted. This latest opinion declines to find an affirmative duty to disclose unsolicited information about proposals under serious consideration, so it does not break new ground in that respect. However, the court also addresses the issue of whether an affirmative duty exists to follow up with an employee who made an inquiry prior to the time the proposal was under serious consideration. If, in the course of inquiring about possible plan changes, the employee asks to be kept abreast of any changes in the status of the potential change, and the employer (or its representative) provides assurances to that effect, then the employer does have an affirmative fiduciary duty to follow up with the employee once the proposal is under serious consideration. However, in the absence of such assurances, there would be no duty to follow up. The case is remanded for the district court to determine when the benefit enhancement was under serious consideration. If the district court determines that the enhancement was under serious consideration before Bins retired, the court will then have to determine whether: 1) it was under serious consideration when Bins was inquiring, which may result in a finding that the employer's representatives did not provide sufficient disclosure to Bins at that time, or 2) it was under serious consideration after Bins' last inquiries, in which case the court will also have to determine whether the company agreed to follow up with Bins.

Since participant was wrongfully denied distribution before his death, payment of his account following his death are property of his estate, not distributable as death benefits to his surviving spouse in a beneficiary capacity (added August 28, 2000). The litigation in Belfer v. Zee, 24 EBC 2163 (3rd Cir. June 8, 2000), has gone on for several years. Norbert and Linda Belfer were divorced in 1990. At that time, in a property settlement agreement, they agreed to designate their children as beneficiaries of their profit sharing plan interests. However, when Norbert remarried, he named his second wife, Corinne, to replace his children as the beneficiary of his account. Later, when Norbert terminated employment with the company, he attempted to receive distribution of his account. The plan administrator, Zee, who is Norbert's daughter, refused to make the distribution. Norbert followed up with another distribution request, this time under the plan's disability provisions, because he had cancer. Zee also denied that request. She had denied both requests on the basis that the property settlement agreement was in effect a QDRO that required benefits to be paid to the children (which included the daughter). Norbert filed an ERISA benefit claim against the plan. He subsequently died, and Corinne was substituted as plaintiff. In an earlier opinion, the court ruled that the property settlement agreement was not a QDRO and that the benefits should be paid to Norbert. See Belfer v. Zee, 166 F.3d 1204 (3rd Cir. 1998). The issue now is how the payment of benefits should be characterized. Corinne is the executor of Norbert's estate but also the beneficiary under the plan. She is arguing that since Norbert has died, the payment of his account should be made to her in her capacity as the designated beneficiary. The language of the plan is also consistent with this, in that a participant's surviving spouse is the beneficiary in full, unless the spouse has consented to another beneficiary. However, the court ruled that since Norbert was wrongfully denied the distribution before his death, the payment must be characterized as a pre-death payment, which is now payable to his estate. The court ordered the plan to pay the benefits to Corinne in her capacity as the executor, and not in her capacity as the surviving spouse of death benefits. What are the consequences of this order? The payment will be an asset of the estate and, thus, available to pay liabilities of the estate. More importantly, disposition of the proceeds from the plan will be subject to the will (or intestacy rules, if Norbert died intestate). Corinne will not be entitled to rollover the distribution to an IRA, because she is not entitled to treat the payment as a death benefit to her in a survivor capacity.

401(k) participants could purchase long-term disability insurance as investment option; incidental insurance limits apply; proceeds treated as trust earnings for §415 purposes (added August 11, 2000). A recent private letter ruling, PLR 200031060, deals with a 401(k) plan which allows participants to allocate a portion of their salary deferral contributions to purchase long term disability insurance (LTDI). The premium is deducted from the participant's account balance on a monthly basis. If the participant subsequently becomes disabled, the policy makes payments to the plan, following a 365-day waiting period. The benefits are equal to one-half of the elective deferrals, employer matching contributions and QNECs made to the plan on behalf of the participant for the plan year immediately preceding the year in which the disability begins. The plan treats the policy payments as investment earnings, which are allocated to the account of the participant who purchased the LTDI coverage. Policy payments allocated to a participant's account can then be invested by the participant in other investment options available under the plan. The purpose of this option is to create annual accumulations in the participant's account after the onset of the disability, to replace the loss of income and the participant's inability to make additional deferrals and to receive additional matching contributions. The IRS made the following rulings: 1) The LTDI insurance is subject to the incidental insurance benefit rules set forth in Rev. Rul. 61-164, Rev. Rul. 74-307 and Rev. Rul. 76-353. Providing protection to the participant from the economic loss that would occur if he were unable to continue making contributions to the plan is a current benefit. Consequently, the payment of premiums under the LTDI policy on behalf of a participant is an incidental insurance benefit that must be subject to these limitations. If the premiums violate the incidental insurance limits, the continued qualification of the plan would be jeopardized. 2) The participant does not include in gross income the amount paid by the participant's account for premiums. There are no "P.S. 58 costs" taxable to the participant, as there are with purchases of life insurance. In addition, the receipt by the participant's account of payments under the policy is not subject to income taxation. Pursuant to IRC §402(a), the participant is not subject to taxation until distributions are actually paid to him from the plan. 3) Since the policy payments are treated as investment earnings on the LTDI investment held by the participant's account, the payments are not annual additions for IRC §415 purposes. 4) The use of 401(k) contributions to purchase the LTDI policy is not a violation of the contingent benefit rule under IRC §401(k)(4)(A). IRC §401(k)(4)(A) provides that employer-provided benefits (other than matching contributions) must not be contingent on an employee's election to defer. However, in §1.401(k)-1(e)(6)(ii) an exception is made for life insurance purchased with a participant's contributions. The IRS ruled that the same exception applies to disability insurance.

PBGC explains its Early Warning Program, which is designed to protect Title IV insurance program (added August 11, 2000). In PBGC Technical Update 00-3, released on July 24, 2000, the PBGC explains its Early Warning Program, which is designed to avoid forced plan terminations under ERISA section 4042 by working with plan sponsors to obtain protections before a business transaction significantly increases the risk of loss. The PBGC is focusing on business transactions conducted by two types of companies: 1) financially-troubled companies, and 2) companies with pension plans that are underfunded on a current liability basis. A financially-troubled company has a below investment-grade bond rating. If such a company has a pension plan with current liability in excess of $25 million, the company meets the criteria for contact under the Early Warning Program. The actual underfunding status of the plan is irrelevant here because the company itself is financially-troubled, presenting a risk with respect to future funding that might become necessary if the plan were to remain active. Alternatively, if a company maintains a pension plan that has a current liability in excess of $25 million and an unfunded current liability in excess of $5 million, the company also satisfies the PBGC's screening criteria, regardless of the company's bond rating. Here, the PBGC is concerned because of the size of the potential underfunding. The PBGC chose these criteria because the information is easy to obtain and the criteria are easily understood by companies. Through the Early Warning Program, the PBGC will try to obtain more information about these companies. In particular, the PBGC will inquire about business transactions that could substantially weaken the financial support for the pension plan. The PBGC lists the following examples of such business transactions: 1) a breakup of a controlled group, including the spin-off of a subsidiary, 2) the transfer of significantly underfunded pension liabilities in connection with the sale of a business, 3) a leveraged buyout, 4) a major divestiture by an employer who retains significantly underfunded pension liabilities, 5) a payment by the corporation of extraordinary dividends, and 6) a substitution of secured debt for a significant amount of previously unsecured debt. In addition to the Early Warning Program, the PBGC also obtains financial and actuarial information about certain companies and their plans through the annual reporting required under ERISA §4010 and through the reporting of "reportable events" described in ERISA §4043. The PBGC is also encouraging companies to contact the PBGC in advance of a proposed business transaction. The company can avoid any uncertainty about whether the transaction raises any PBGC concerns and minimize any disruption in corporate plans or actions.

Proposed regulations issued to cover loan refinancing, military service leave, and multiple loans (added July 31, 2000). Prop. Treas. Reg. §1.72(p)-1, Q&A-9(b) and (c), Q&A-19, Q&A-20, Q&A-22(d), 65 F.R. 46677 (July 31, 2000), supplement final regulations issued today under IRC §72(p) (summary of the final regulations appears after the summary of these proposed regulations). The purpose of the proposed regulations is to provide guidance on the refinancing of loans, multiple loans, suspension of loans during military service, and loans made when a defaulted loan is still outstanding. The proposed regulations will apply to loans made on or after the first January 1 which is at least six months after the regulations are finalized. Since January 1, 2001, is already less than six months away, the earliest effective date for the rules contained in these proposed regulations will be January 1, 2002 (assuming final regulations are issued by June 30, 2001). For earlier loans, a reasonable, good faith compliance standard applies. Presumably, following these proposed regulations will satisfy this good faith standard.

• ¶1. Refinancing transactions. One of the issues that has perplexed plan administrators is how to apply the rules of IRC §72(p) when an existing loan is refinanced, or a new loan is made that also repays the existing loan. Some administrators have employed a very conservative approach, prohibiting any additional loans until an existing loan is fully repaid and prohibiting the refinancing or renegotiation of an existing loan. In The ERISA Outline Book, we have provided suggested methods for using refinancing transactions to replace an existing loan. See Chapter 7, Section IX, Part B.1.b., of the 1999-2000 edition. Happily, these proposed regulations adopt the arguments we have used in the Outline Book to support these suggested methods.
• Definition of a refinancing transaction. Proposed Q&A-20(a) defines a refinancing as any situation in which one loan replaces another. This might occur because the participant wants to add to the outstanding loan amount, but does not want to, or the plan will not permit him to, have more than one loan outstanding at a time. This also might occur because the interest rate or the repayment term is being renegotiated (e.g., to reflect a lower interest rate, or to provide more time to repay the outstanding loan balance). A refinanced loan is treated as a new loan for purposes of §72(p). That means the interest rate and the security interest on the refinanced loan must be determined as of the date of the refinancing. Thus, the interest rate under the replaced loan might not be an appropriate interest rate under the refinanced loan, because the plan must now redetermine what is a commercially reasonable interest rate. In addition, the 50% limit under IRC §72(p)(2)(A) must be redetermined to take into account the participant's vested accrued benefit as of the date of the refinancing.
• How to apply §72(p) to refinancing transactions. If the loan that is replacing the original loan (the replacement loan) has a term which ends later than the term of the loan being replaced (the replaced loan), then both the replacement loan and the replaced loan are treated as outstanding on the date of the refinancing transaction. See Proposed Q&A-20(a)(2). Thus, two loans collectively must satisfy the requirements of IRC §72(p), or there will be deemed distribution consequences, in accordance with the rules set forth in the §72(p) regulations. For example, if the sum of the amount of the replacement loan and the outstanding balance of the replaced loan (plus any other existing loans not being replaced) exceeds the amount limitations under IRC §72(p)(2)(A), the excess is taxed as a deemed distribution. However, if the term of the replacement loan does not end later than the term of the replaced loan, the replaced loan is disregarded in determining whether the replacement loan satisfies §72(p), and only the amount of the replacement loan (plus the outstanding balance of any existing loans that are not being replaced) are taken into account.

  Exception. The rule described in the first sentence of the prior paragraph does not apply if the replacement loan would satisfy §72(p)(2) if it were analyzed as two separate loans - one representing the replaced loan, amortized in substantially level payments over a period ending no later than the last day of the original term of that replaced loan, and the other one representing the difference between the amount of the replacement loan and the outstanding balance of the replaced loan. In other words, if the replacement loan would effectively amortize an amount equal to the replaced loan over a period that does not exceed the original term of the replaced loan, the Treasury does not feel that the refinancing transaction is being used to circumvent §72(p), so there is no need to take into account the outstanding balance of the replaced loan to determine whether the amount of the replacement loan satisfies §72(p). When this exception applies, the plan only needs to take into account the amount of the replacement loan plus any existing loans which are not being replaced to determine if the §72(p)(2) limitations are violated. The following two examples illustrate these rules. Additional examples are provided in the proposed regulations.

• Example - increasing loan and starting new 5-year term. Will has a vested account balance of $23,000 as of December 1, 2002. He receives a loan for $8,000. The loan bears the maximum 5-year payment term, so the loan will not be fully amortized until November 30, 2007. On June 1, 2004, Will has an outstanding balance of $6,000 on the original loan. As of that date, his vested account balance is $32,000. Will's loan limit is now $16,000 (i.e., 50% x $32,000), $6,000 of which is outstanding. Will needs $4,000 additional cash. The plan lends Will another $4,000 on June 1, 2004, and starts a new 5-year repayment term ending May 31, 2009. The new loan requires monthly amortization (deducted through payroll withholding). The principal of the new loan (i.e., the replacement loan) is $10,000, which represents the $4,000 of additional cash given Will and the $6,000 outstanding balance on the original loan (i.e., the replaced loan). In other words, the replacement loan pays off the outstanding balance of the replaced loan, and also gives Will another $4,000. The refinancing transactions satisfies the requirements of Proposed Q&A-22. The replaced loan had an outstanding balance of $6,000. The replacement loan is for $10,000. Since the repayment term of the replacement loan ends after the term of the replaced loan, the plan must treat both loans as outstanding on June 1, 2004, to determine if the §72(p)(2) limits have been exceeded. If we add the loans together, we get a total of $16,000. Will's 50% limit under §72(p)(2)(A) is $16,000 because, as of the date of the replacement loan, Will's vested account balance is $32,000. In addition, the repayment rules of §72(p)(2)(B) and (C) have not been violated by either loan. Compliance with the repayment rules is determined separately with respect to each loan because the replacement loan is treated as a separate, new loan. The replaced loan had a term that would have ended on November 30, 2007. The loan, during its existence, satisfied the level amortization requirements, and the refinancing transaction has resulted in that loan being paid in full. The replacement loan also does not violate §72(p)(2)(B) and (C). It has a repayment term that does not exceed 5 years from the date of that loan, and the loan provides for level amortization on at least a quarterly basis. The plan could have made a separate loan to Will in the amount of $10,000, assuming the plan permits more than one loan to be outstanding at a time. A new loan of $10,000 plus an outstanding loan balance of $6,000 would have equaled Will's maximum loan limit on June 1, 2004, which is $16,000. Will could then have used $10,000 of the proceeds from the second loan. The net effect of this alternative approach is the same as the refinancing example, illustrating why the proposed regulations approve of the refinancing transaction. By disbursing an additional $4,000 to Will and treating a new loan of $10,000 to have started on June 1, 2004, the plan is simply consolidating steps.
• Example - 50% loan limit would be exceeded if replacement loan were added to outstanding balance of replaced loan. Let's modify the prior example slightly. Suppose Will's vested account balance as of June 1, 2004, is only $26,000, because of market fluctuations on his non-loan investments in his account. Now, Will could not have two loans outstanding that total $16,000, because his maximum loan limit is only $13,000. Therefore, the plan can't treat Will as receiving a second loan for $10,000, and using $6,000 of the proceeds from the second loan to retire the first loan, as suggested in the prior example. What options are available here?

  Option #1 - separate loans (i.e., don't do any refinancing). Make a separate loan for $4,000 (rather than for $10,000), which is the additional cash that Will needs. The origination date of the separate loan is June 1, 2004. Will continues to amortize his original loan over its remaining term (which ends November 30, 2007), which has a balance of $6,000 at this time, and he starts a new amortization period on the second loan of $4,000, which would have a separate repayment term that could end as late as May 31, 2009 (i.e., 5 years after the origination date). This option is available only if the plan permits Will to have more than one loan outstanding at a time. Since the original loan is not being replaced by the second loan, the plan simply adds the outstanding balance of the first loan to the amount of the second loan to determine if the limits of §72(p)(2)(A) are satisfied, using Will's vested account balance at the time of the second loan to make such determination.

  Option #2 - refinancing of the original loan with original repayment term. Another option is to consolidate Will's loans into a single loan of $10,000 as of June 1, 2004, through a refinancing transaction. The replacement loan is for $10,000, but only $4,000 is disbursed to Will because the other $6,000 is used to payoff the original loan. However, the repayment term of the replacement term ends November 30, 2007, which is the same date as the original loan. Since the term of the replacement loan is not later than the term of the replaced loan, the plan does not treat the replaced loan as outstanding at the time of the replacement loan for purposes of §72(p)(2). Proposed Q&A-20(a)(2) applies only if the term of the replacement loan ends later than the term of the replaced loan. Thus, the plan looks only at the replacement loan to determine if the limitations under §72(p)(2)(A) have been exceeded. A loan of $10,000 does not exceed Will's loan limit of $13,000, so §72(p)(2)(A) is not violated. In addition, the replacement loan has a repayment term that does not exceed the 5-year rule under §72(p)(2)(B) and the amortization schedule satisfies the requirements of §72(p)(2)(C). After the refinancing transaction, Will's loan payments will be greater because he is amortizing a greater amount over the remainder of the term of the replaced loan.

  Option #3 - refinancing of the original loan with a new repayment term which amortizes the original loan within its original term. Under this option, the plan disburses $4,000 to Will and consolidates the first loan and the second loan into a refinanced loan for $10,000, as under Option #2, effective June 1, 2004. The difference from Option #2 is that instead of having the $10,000 loan fully amortized by November 30, 2007 (as under Option #2), the new loan has a full 5-year amortization term that ends May 31, 2009, (or an earlier date that is later than November 30, 2007). However, the amortization schedule is structured so that at least $6,000 of the principal (which was the loan balance on the replaced loan at the time of the refinancing) is amortized by the original term of the replaced loan (i.e., November 30, 2007), and the difference is amortized on a level basis during the new 5-year term. This would be accomplished by having Will's payments through November 30, 2007, equal the payments under the replaced loan (as adjusted, if necessary, to reflect a change in the applicable interest rate under the refinanced loan) plus an additional amount needed to amortize the additional $4,000 over a 5-year period starting June 1, 2004, and his payments from December 1, 2007, through May 31, 2009, equal only to the amount needed to finish amortizing the additional $4,000. To illustrate, suppose the replaced loan had monthly payments of $100, and monthly amortization of an additional $4,000 over 5 years requires additional monthly payments of $65. Also suppose that there has been no change in the interest rate. Under this option, Will would pay $165 per month under the replacement loan until November 30, 2007, and then only $65 for December 2007 through May 2009. Since the outstanding balance of the replaced loan is still being repaid by November 30, 2007, the plan does not treat the replaced loan as outstanding at the time of the replacement loan for purposes of §72(p)(2). See Proposed Q&A-20(a)(2). Thus, the plan looks only at the replacement loan to determine if the limitations under §72(p)(2)(A) have been exceeded. A loan of $10,000 does not exceed Will's loan limit of $13,000, so §72(p)(2)(A) is not violated. In addition, the replacement loan has a repayment term that does not exceed the 5-year rule under §72(p)(2)(B) and the amortization schedule satisfies the requirements of §72(p)(2)(C) (the drop in the amortization payment after November 30, 2007, is not treated as violating the level amortization requirement).

  Option #4 - bridge loan to repay first loan. Under this option, Will obtains a third-party loan for $6,000 to repay the outstanding balance on the first loan. He then requests $10,000 as a new loan from the plan. The $10,000 will not violate Will's 50% limit under §72(p) because the $6,000 outstanding balance on the first loan has been repaid before the $10,000 loan is taken. The $10,000 loan can have a 5-year amortization term. Will then uses $6,000 of the proceeds from that loan to repay the third-party lender. The guidance in Proposed Q&A-20 makes this option the least desirable, because the other options, which satisfied the proposed regulation, eliminate the need to involve an outside lender. However, if the plan does not permit refinancing transactions, and also does not allow for more than one loan to be outstanding at a time, Will would have to use this option to accomplish his desired result.

• ¶2. Multiple loans. If a participant receives multiple loan, each loan must satisfy §72(p), taking into account the outstanding balance of each existing loan, as under current rules. The refinancing rules discussed in ¶1. above do not apply because the new loan is not replacing the existing loan(s). However, Proposed Q&A-20(a)(3) establishes a limit of two loans within the same calendar year. The plan may apply this rule on a plan year basis or on the basis of another consistent 12-month period, rather than the calendar year. If a loan is made in violation of this rule, the entire amount is treated as a deemed distribution, even if the limits of IRC §72(p)(2) are otherwise satisfied. The Treasury is concerned that too many loans within a year might circumvent the §72(p)(2) limits, particularly with respect to the $50,000 maximum loan limit under §72(p)(2)(A)(i). Note that this rule will not take effect until these proposed regulations are finalized. See the effective date information at the beginning of this summary. For loans made before the effective date, the plan may allow more than two loans in a year, and the loan limits must be applied to each loan under a reasonable, good faith interpretation of §72(p).
• ¶3. Loans made while a deemed distribution loan remains unpaid. A loan that is deemed distributed under §72(p) is considered outstanding for purposes of applying the loan limits under §72(p)(2)(A) until the loan is repaid (either through payments made by the participant or by a loan offset). See Q&A-19(b) of the final regulations issued today. Proposed Q&A-19(b)(2) will establish additional requirements on a subsequent loan that is made before the deemed distributed loan is repaid. If these conditions are not satisfied, the subsequent loan is treated in its entirety as a deemed distribution under §72(p). To satisfy Proposed Q&A-19(b)(2), one of the following conditions must be met: 1) repayments on the subsequent loan are made under a payroll withholding arrangement that is enforceable under applicable law, or 2) the plan receives adequate security from the participant that is in addition to the participant's accrued benefit under the plan (i.e., the plan obtains other collateral for the loan). The payroll withholding arrangement described in 1) may be revocable but, if the participant later revokes the arrangement, the outstanding balance of the loan is deemed distributed. Similarly, if the additional collateral is no longer in force before the subsequent loan is repaid, the outstanding balance of the loan becomes a deemed distribution.
• ¶4. Military service. Proposed Q&A-9(b) and (c) are revised to incorporate more guidance under IRC §414(u)(4), which allows participant loans to be suspended for any period during which the employee is performing service in the uniformed services, regardless of whether the service is qualified military service under the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA). Proposed Q&A-9(b) clarifies that the suspension may exceed one year, unlike the suspension rules in Q&A-9(a) for other leaves of absence. To satisfy the loan repayment requirements of IRC §72(p)(2)(B) and (C), loan repayments must resume upon completion of the military service, and the frequency and amount of each installment payment upon resumption is not less than the frequency and amount under the terms of the original loan. Furthermore, the loan must be repaid in ful (including interest that accrues during the period of military service) by the end of the period which equals the original term of the loan plus the period of the military service. For example, if the original loan term ends June 30, 2004, and a two-year military service period is taken during that original loan term, the loan must be repaid in full by June 30, 2006. The resumed payments can be the same as they were before the military service period began, resulting in a balloon payment of the remaining balance due no later than June 30, 2006, or the amount of the payments can be increased so that the balance due no later than June 30, 2006, is either zero, or a reduced amount.
• Example. On July 1, 2001, a participant borrows $40,000, to be repaid in level monthly installments of $825 each over 5 years. The participant makes 9 monthly payments and then commences a two-year military service period, which ends on April 2, 2004. The participant resumes actives employment on April 19, 2004, and continues making monthly installments of $825 until June 30, 2008 (i.e., the date which is two years from the original term of June 30, 2008, to take into account the period of military service). As of June 30, 2008, the unpaid balance of $10,527 becomes due. Alternatively, the monthly installments could be increased to $983 in order to repay the loan in full by June 30, 2008, without any balloon payment due at that time. This example appears as Example 2 under Proposed Q&A-9(c).

Final regulations explain requirements for nontaxable loans, tax treatment of defaulted loans (added July 31, 2000). Treas. Reg. §1.72(p)-1, Q&A-1 through Q&A-19, and Q&A-21 through Q&A-22, 65 F.R. 46588 (July 31, 2000), provide guidance, in question-and-answer format, on the tax issues relating to participant loans, as set forth in IRC §72(p). A loan is taxed as a distribution unless it satisfies the requirements of §72(p)(2). The regulations finalize two sets of proposed regulations, one issued in 1995 and the other issued in 1998. The 1998 proposed regulations supplemented the 1995 proposed regulations, to provide guidance on the treatment of accrued interest after a plan loan is deemed to be distributed under section 72(p), tax basis issues relating to a deemed distribution, and the effective date of the regulations. Along with these final regulations, the Treasury is issuing a new set of proposed regulations (see the separate summary above) to address refinancing transactions, the tax treatment of multiple loans, and military service leave.

• Effective date. The regulations are effective for loans made on or after January 1, 2002. See Q&A-22(b). (The 1998 proposed regulations clarified that the effective date would be no earlier than the January 1 which is at least 6 months following the publication of final regulations.) The plan year of the plan is irrelevant. In other words, all plans become subject to the regulations as of January 1, 2002, even if that date occurs in the middle of a plan year. This effective date does not mean that plans may ignore IRC §72(p) before January 1, 2002. The statutory effective date of §72(p) was for loans made after August 13, 1982 (although the quarterly amortization rule and some changes to the principal residence loans did not apply until after 1986). Between the applicable statutory date of any provision of §72(p) and the regulatory effective date, plan administrators must apply a reasonable, good faith standard of compliance. Compliance with the proposed regulations, or any provisions of these final regulations, before the regulatory effective date would be treated as satisfying the good faith compliance standard. The final regulations follow the proposed regulations very closely, so a detailed analysis is not provided in this summary. Here are some highlights.
• Cure period for defaulted loans. The final regulations retain the rules for correcting missed loan payments before a deemed distribution, due to default, must be triggered. The proposed regulations had referred to this as a "grace period," but the final regulations call it a "cure period." Q&A-10(a) of the regulations permits the cure period to run through the end of the calendar quarter that follows the calendar quarter in which the missed installment payment was due. When the loan is in default (taking into account any permitted cure period), the entire balance due is taxable, including accrued interest through the date of default.

  Example. A participant is making monthly installments on a loan from the plan. The participant misses the payment due August 31, 2003, and subsequent monthly payments. The provides a 3-month cure period. The cure period for the August 31, 2003, payment ends November 30, 2003. The amount is not paid by then. The taxable distribution is $17,157, which represents the participant's outstanding loan balance, but interest accrued through November 30, 2003. In an alternative scenario, the regulations provide that the plan's cure period ends on the last day of the calendar quarter following the quarter in which the installment payment is missed. In that case, the cure period would not end until December 31, 2003, so there would be an additional month of accrued interest. In the example, the taxable distribution is increased to $17,282.

• Guidance on electronic media.The regulations require that the loan be evidenced by an enforceable agreement that sets forth: the amount of the loan, the date of the loan, and the repayment schedule. See Q&A-3(b). The enforceable agreement may be in the form of a written paper document or in an electronic medium. The principles set forth in Treas. Reg. §1.411(a)-11(f)(2), regarding the use of electronic media to obtain participant consent to a distribution, are applied here as well. The electronic medium must: 1) be reasonably accessible to the participant, 2) be reasonably designed to preclude any individual other than the participant from requesting a loan, 3) provide a reasonable opportunity for the participant to confirm, modify or rescind the terms of the loan before the loan is made, 4) provide confirmation of the loan within a reasonable time after the loan is made. Confirmation may be provided in a paper document or electronically. If the confirmation is provided electronically, it must be designed in a manner that is no less understandable than a written paper document, and the participant must be advised that he or she may request a written paper document at no charge. An agreement does not have to be signed by the participant, so long as under applicable law, the agreement is legally enforceable without a signature. The purpose of this clarification in the final regulations is to enable plans to process loans electronically without a signature, if such procedure does not compromise the enforceability of the loan agreement. The IRS had taken this position in an informal ruling issued on June 26, 1997, which was reprinted in CCH Pension Plan Guide, ¶17,396L.
• Accruing interest on defaulted loansQ&A-19 addresses the treatment of accrued interest following the taxation of a loan as a deemed distribution, adopting the rules as they were stated in the proposed regulations. After a loan is deemed distributed under section 72(p) (e.g., the plan goes into default, as described in Q&A-10), interest that accrues thereafter is disregarded for section 72 purposes. That means the accrued interest is not taxable, neither at the time it accrues nor at the time the loan receivable is later offset. However, until an offset occurs, the accrued interest is taken into account to determine the maximum amount of any subsequent loan to the participant. (Note that the offset is an actual distribution event and cannot be permitted before an actual distribution is permitted under the plan. Until there is an actual distribution, the loan is not treated as a distribution for qualification purposes, only for tax purposes.)
• Example. Lynn borrows $10,000 from her employer's profit sharing plan. The loan is not repaid through payroll withholding deductions. Instead, Lynn must make monthly installment payments by writing a check to the plan for each payment. As of December 31, 2002, the outstanding balance becomes a deemed distribution because of a monthly payment missed on September 30, 2002. (Lynn makes no payments between September 30, 2002, through December 31, 2002, that can be treated as covering the missed payment.) The outstanding balance as of December 31, 2002, is $8,250 (which includes accrued interest through that date). That amount is taxed as a deemed distribution under section 72(p). Under the terms of the plan, distribution is not available to Lynn, so the loan amount cannot be offset at the time of default. After December 31, 2002, interest continues to accrue at $200 per month. The post-2002 accrued interest is not included in Lynn's income. However, the accrued interest is added to the deemed distribution amount ($8,250) to determine whether any subsequent loan made to Lynn satisfies the limitations under section 72(p). As a non-401(k) profit sharing plan, the plan could be written to treat default as a distribution event, which would trigger a loan offset, i.e., an actual distribution, coincident with the default. The example assumes the plan does not contain this provision. If such a provision were in the plan, Lynn's account would be offset by the unpaid loan balance, and would be reported as an actual distribution, rather than as a deemed distribution. No interest would accrue and there would be no outstanding loan to Lynn if a new loan were to be made to her. Note that proposed regulations also issued today (see separate summary above) would impose additional conditions if another loan is made to the participant before the defaulted loan is offset. These conditions are designed to ensure that any subsequent loan is more likely to be repaid.
• No basis credited because of deemed distribution/reporting rules when defaulted loan is later offset. When a loan becomes a deemed distribution, the amount taxed is not credited as tax basis. However, see the transition rule in Q&A-22(c), where accrued interest that was taxed as a deemed distribution is treated as tax basis. When the plan offsets the loan receivable, the offset amount is not reported again as part of the participant's gross distribution. In other words, the prior deemed distribution of the loan is treated as the distribution of that loan for reporting purposes, so the cashless portion of the distribution that represents the loan offset is not reported. Since the loan receivable is not reported when it is offset, there is no need to credit basis for that loan. Interest that accrues after the deemed distribution is also not reported as part of the gross distribution when the loan offset later occurs, even though the accrued interest was not previously subject to taxation.

  Example. Bill defaulted on a participant loan in 2000. At the time of the default, the plan deemed a distribution of $12,150. That was reported on Form 1099-R for the calendar year in which the default occurred. The loan receivable remained an asset of the plan because there was no distribution event with respect to the defaulted amount. The plan posted accrued interest, but did not report it as a deemed distribution. In 2003, Bill terminates employment and requests a lump sum distribution of his account. At the time of the distribution, Bill's account consists of $61,300 cash and $15,250 loan receivable, (which includes the $12,150 initial default amount and $3,100 accrued interest). The plan offsets the loan receivable and the accrued interest and distributes the cash (20% of which is withheld for federal income taxes). The Form 1099-R should report a gross distribution of $61,300, which is the cash portion of Bill's account, and shows the same amount as the taxable distribution because Bill does not have any tax basis. He does not get tax basis for the previously-taxed loan because the loan offset is not reported as part of the gross distribution. Since the loan receivable and the accrued interest are not treated as part of the distribution, the 20% withholding liability is calculated only on the cash portion of $61,300.

• Repayment of previously-taxed loan. If the loan is repaid after the deemed distribution has occurred, the repayments (including repayments of interest) are treated as tax basis. See the example in Q&A-21(b). To the extent a previously-taxed loan is repaid, that portion is no longer a receivable, but reflects part of the non-loan assets included in the participant's account balance (or accrued benefit, in the case of a defined benefit plan). That portion is part of the reportable gross distribution, so the tax basis generated from those repayments is taken into account to determine the taxable portion of that gross distribution. Note that loan repayments are not treated as employee contributions for purposes of the nondiscrimination test under §401(m) nor for purposes of the §415 limits, even though tax basis is generated by such loan repayments. See the last sentence of Q&A-21(a).

  Example. Suppose in the above example that Bill recommenced loan payments in 2002. By the time the plan makes the lump sum distribution to Bill, the loan receivable balance is only $10,400. The total loan payments made by Bill after the deemed distribution totaled $5,920, which included additional interest. Now Bill's account consists of $10,400 loan receivable and $69,115 cash. The cash consists of the $61,300 assumed in the prior example, plus the loan repayments of $5,920, plus an additional $1,895 of investment earnings that were generated because of the loan repayments made by Bill. The plan reports a gross distribution of $69,115, but the taxable portion of that distribution is only $63,195. Bill has tax basis of $5,920, which represents his total loan repayments following the deemed distribution of the loan.

Automatic enrollment feature is permissible in 457 plan (added July 24, 2000). In Rev. Rul. 2000-33, IRS confirms that an automatic enrollment feature is acceptable under a section 457 plan. The requirements parallel those prescribed for 401(k) plans under Rev. Rul. 2000-8. If the automatic enrollment feature is properly applied, the contributions deducted from an employee's compensation, for transmittal to the 457 plan, are treated as an agreement to deferral compensation in accordance with IRC §457(b)(4). Under the automatic enrollment feature in the example given in the revenue ruling, the employer deducts 2% of an eligible employee's compensation for contribution to the 457 plan unless the employee makes a contrary affirmative election. The employee's election may be for no deferrals at all, or for a deferral percentage other than 2%. An affirmative election takes effective as of the first day of the month following the month in which the election is made. The automatic enrollment feature is applied to newly-eligible employees as well as to already-eligible employees who, as of the effective date of the automatic enrollment feature, are deferring compensation to the 457 plan at a level which is less than 2% or are not deferring at all. Eligible employees are given a notice that explains the automatic enrollment feature within a reasonable time (not defined in the ruling) before they will become subject to such feature. A newly-hired employee is provided this notice at the time he is hired in order to provide a reasonable time to make an affirmative election before his first payday. IRC §457(b)(4) requires an eligible deferred compensation plan under §457(b) to provide that compensation will be deferred for any calendar month only if an agreement providing for such deferral has been entered into before the beginning of such month. Based on the above facts, the IRS ruled that so long as the obligation to make deferral with respect to an employee's compensation for a month is established before the beginning of a month by either an automatic election, or by an agreement to alter the terms of the automatic election and receive cash in lieu of deferrals (i.e., a contrary affirmative election), an eligible deferred compensation plan, as described in IRC §457(b), will satisfy the requirements of IRC §457(b)(4).

Former spouse's QDRO payments ceased at participant's death because QDRO did not designate her as surviving spouse for purposes of the survivor annuity portion of the benefit (added July 24, 2000) [Citation: Dorn v. Electrical Workers IBEW, 24 EBC 1824 (5th Cir. May 18, 2000)] Jack and Janice divorced in 1991. Jack commenced benefits under his employer's pension plan, in the form of a qualified joint and survivor annuity (QJSA), on March 1, 1993. At that time, Jack was married to Geraldine. The monthly annuity payments under the QJSA were $623 during Jack's lifetime and $312 to his surviving spouse. Prior to the March 1, 1993, annuity starting date, Janice obtained a QDRO that awarded her $302 per month of the annuity payable to Jack. During Jack's lifetime, the plan paid $302 per month to Janice, pursuant to the QDRO, and the remainder to Jack. After Jack's death on May 31, 1997, the plan discontinued the payments to Janice and paid the entire monthly survivor annuity ($312) to Geraldine, who was Jack's spouse at the time of the annuity starting date and also at his death. Janice brought this lawsuit to enforce continued annuity payments to her after Jack's death. The court ruled against her because the QDRO did not address the survivor annuity and did not designate Janice as the surviving spouse for purposes of the plan. ERISA §206(d)(3)(C) permits the former spouse to be designated as the surviving spouse, but only if the QDRO clearly specifies such treatment. Thus, Janice's interest in Jack's benefits, pursuant to the QDRO, ended with Jack's death.

Following division of IRA, spouse of IRA owner need not continue proportionate amount of substantially equal periodic payments commenced by IRA owner before the divorce (added July 24, 2000). [Citation: PLR 200027060] In 1995, at the age of 48, Taxpayer B began receiving substantially equal periodic payments from his IRA. In 1999, B's IRA was divided pursuant to his divorce from Taxpayer A. An amount equal to $65,000, or 13.349% of B's IRA, was transferred to an IRA established for A. The IRS ruled that A is not required to begin receiving distributions from her IRA after the transfer. Furthermore, her decision not to take any periodic payments from the IRA does not result in the imposition of make-up penalties under IRC §72(t)(4). The IRS reached this conclusion on the basis of the language in IRC §408(d)(6), which provides that an IRA interest transferred pursuant to a decree of divorce is treated as an IRA of the former spouse Taxpayer A in this case) who is awarded that interest, and not the individual who originally owned the IRA interest (Taxpayer B in this case). Thus, A's failure to take a portion of the periodic payments is not treated as a discontinuance of the substantially equal payments election under B's IRA for §72(t) purposes. The ruling does not address the consequences on B's IRA. Presumably, to avoid make-up penalties under IRC §72(t)(4), B will need to continue to receive the substantially equal periodic payments in accordance with the calculation method in effect. In addition, the payment of a portion of B's IRA to A's IRA, pursuant to the divorce, should not be treated as a modification of B's substantially equal payment method in effect, so long as B continues to receive the periodic payments from his IRA after the divorce.

As an interesting sidenote, in PLR 9739044 the husband and wife, after the divorce, proportionately divided the monthly periodic payments in effect at the time of the divorce. In that ruling, the IRS concluded that the makeup penalties under IRC §72(t)(4) also did not trigger. It was not clear in PLR 9379044 whether the former spouse had to continue a proportionate share of the IRA owner's periodic payments. PLR 200027060 discussed above clearly says that the former spouse does not. The approach taken in PLR 9739044 obviously will work only if the former spouse is cooperative. In PLR 200027060, the former spouse (Taxpayer A) was apparently not willing to shoulder any responsibility for the post-divorce periodic payments. This requires the IRA owner (Taxpayer B) to bear the entire burden of the continued periodic payments, only now they will be made from a reduced IRA following the divorce.

Lookback rule for involuntary distributions repealed by Treasury (added July 21, 2000). In Treas. Reg. §1.411(a)-11(c)(3) and §1.417(e)-1(b)(2), published in 65 F.R. 44679 on July 19, 2000, the Treasury Department eliminates the so-called "lookback rule" for making involuntary cash-out distributions. Under the lookback rule, the prior regulations under §1.411(a)-11 provided that if, at any time, a participant received a distribution when his vested benefit exceeded the involuntary cash-out limit, the participant's vested benefit was forever deemed to be greater than the involuntary cash-out limit. The lookback rule applied even if the prior distribution was made under a separate event (e.g., in-service withdrawal) from the one triggering the current distribution (e.g., termination of employment). In December 1998, temporary regulations were issued (§1.411(a)-11T(c)(3)(i)) to eliminate the lookback rule for consents required under IRC §411(a)(11), except for certain periodic distributions that were already in progress. Under the temporary regulations, if a periodic distribution was in effect (e.g., an installment distribution), and at least one scheduled payment still remained, the lookback rule still applied if the first periodic payment was made when the vested benefit exceeded the cash-out limit (i.e., $5,000). The temporary regulation did not eliminate the lookback rule for consents required under IRC §417 (relating to waivers of the qualified joint and survivor annuity (QJSA)), but proposed regulations were issued in conjunction with the temporary regulations to completely eliminate the lookback rule, even for section 417 distributions. These final regulations adopt the proposed regulations, and discontinue the restrictions in the temporary regulations on the elimination of the lookback rule. Thus, for all plans, including plans subject to the QJSA rules under §417, the lookback rule is now eliminated.

• Example - prior hardship withdrawal. In a prior year, Jason received a hardship withdrawal from his employer's 401(k) plan when his vested account balance exceeded $5,000. Jason has now terminated employment. The plan provides for an involuntary lump sum payment if a participant's vested benefit does not exceed $5,000. Jason's current vested account balance is less than $5,000. With the elimination of the lookback rule, the plan need not treat Jason's vested account as forever over $5,000 merely because of the prior hardship withdrawal.
• Example - installment distributions. Mandy commenced installment distributions in 1994 under a profit sharing plan that is not subject to the QJSA rules under §417. At the time of the first installment distribution, Mandy's vested benefit exceeded $5,000. Mandy's undistributed vested benefit is now less than $5,000. There are four scheduled installment distributions left. With the elimination of the lookback rule, the plan may involuntarily cash-out Mandy's undistributed vested benefit in lieu of making the remaining scheduled installments distributions.
• Temporary regulations had different result. Under the above facts, the temporary regulations would have precluded the involuntary cash-out of Mandy's benefit because, at the time her periodic distribution payments commenced her vested account balance was over $5,000. However, the final regulations eliminate this restriction. Now, so long as the current vested balance is not over $5,000, the plan may provide for the involuntary cash-out even if the participant is in pay status under a periodic distribution method. Caution: QJSA issue. In Mandy's example above, the plan could not make the involuntary cash-out if the plan is subject to the QJSA rules under §417(e). That's because the payment would be made after the annuity starting date. See the discussion of the annuity starting date issue later in this summary.
• Example - plan subject to QJSA. Fernando has reached normal retirement age under his employer's money purchase plan. The plan permits in-service withdrawals after a participant has reached normal retirement age. Fernando withdraws 90% of his vested account balance, pursuant to this in-service withdrawal provision. The in-service withdrawal is in a single sum, pursuant to Fernando's waiver of the QJSA, with his spouse's consent, with respect to the portion of his account being withdrawn. At the time of the in-service withdrawal, Fernando's vested account balance exceeds $5,000. Fernando then terminates employment. As of his termination of employment, Fernando's vested account balance is $4,200. The plan provides for an involuntary cash-out distribution, as soon as administratively feasible following termination of employment, if a participant's vested account balance is $5,000 or less. With the elimination of the lookback rule, the involuntary cash-out distribution provision in the plan will apply to Fernando. His prior in-service distribution no longer affects the application of the involuntary cash-out rule.
• Temporary regulations would have precluded involuntary distribution in the above example. The temporary regulations would have required Fernando to consent to the termination distribution, even though it was under $5,000, because the temporary regulations did not eliminate the lookback rule for plans subject to the QJSA rules under §417. (A money purchase plan is always subject to the QJSA rules.) The final regulations eliminate the lookback rule for all plans.
• Distribution occurs before the annuity starting date. Fernando's distribution is a lump sum cash-out of the vested interest prior to the annuity starting date. Therefore, the consent requirement discussed below is not applicable.
• In-service withdrawal required spousal consent. Note that when Fernando elected the in-service withdrawal he had to waive the QJSA with his spouse's consent in order to receive the distribution in a single-sum. It is because of these waiver and consent rules that the Treasury felt the elimination of the lookback rule created little potential for abuse, even in the plans subject to the QJSA rules. Although the remaining vested account at the time of Fernando's termination will now be cashed-out without his or his spouse's consent, the bulk of his vested account balance was paid under the in-service withdrawal provision in accordance with the QJSA rules.
• Distributions after the annuity starting date under QJSA plans. In conjunction with the complete elimination of the lookback rule, the last sentence of §1.417(e)-1(b)(2)(i) is revised to provide that, after the annuity starting date, the present value of the vested accrued benefit cannot be immediately distributed without the consent of the participant (and spouse, if applicable), regardless of the value of the vested accrued benefit or the form of benefit being paid. In the second example above, involving Mandy, if the plan were subject to the QJSA rules, the cash-out of her remaining vested accrued benefit could not be paid without her (and her husband's) consent because she is passed her annuity starting date (i.e., the date the installment payments commenced).

Effective date of the elimination of the lookback rule. The elimination of lookback rule applies to distributions made on or after October 17, 2000, which is 90 days after the publication of the final regulations. For distribution made before October 17, 2000, the rules in the temporary regulations apply instead.

Plan may provide for direct rollover as the default method of making involuntary distributions in the absence of an affirmative election by the participant (added July 18, 2000). A qualified plan provides for involuntary distributions of vested account balances of $5,000 or less, following termination of employment. There are no after-tax contributions in the plan. Pursuant to IRC §402(f), the plan first provides a notice to the terminated employee, which explains the rollover and withholding requirements. Under the current terms of the plan, if the employee has not affirmatively elected whether to take a cash distribution or to direct a rollover, the plan makes a cash distribution. The employer is now amending the plan to make the direct rollover the default distribution method. Under the amendment, if the employee fails to make an affirmative election within the 30-day minimum election period prescribed by law, the plan will rollover the involuntary distribution to an IRA. The plan administrator selects the trustee, custodian or issuer of the IRA. The default rollover is explained in the notice material provided to the terminated employee. In Rev. Rul. 2000-36, the IRS ruled that a plan may use the direct rollover as the default method of distribution. Pursuant to Treas. Reg. §1.401(a)(31)-1, Q&A-7, the plan must explain the default procedure. The IRS also ruled that the amendment of the plan to change the default distribution procedure from cash to rollover is not a cutback described in IRC §411(d)(6). A change in a default method of distribution does not eliminate any option available from the plan, it only changes the automatic method of payment that is made in the absence of an election among the plan's options.

• Uses of the default rollover procedure. Why might a plan sponsor consider this approach? One reason may be the hassle of having an involuntary distribution outstanding for a long period of time because the participant doesn't cash the check. By using the direct rollover as a default, the plan transfers the funds directly in the IRA, and no check is issued to the participant. The plan satisfies its obligation to pay the benefit, and the participant can take the withdrawal from the IRA when he wishes. A default direct rollover may be a useful tool when dealing with missing participants as well, in particular when a defined contribution plan is terminated and, after taking reasonable steps, the plan is unable to locate several participants. Note that Rev. Rul. 2000-36 does not address missing participant sitations. The facts of this ruling deal solely with situations where the participant receives notice of the pending distribuiton, and an explanation of the right to elect cash or rollover, and the default rollover procedure if no affirmative election is made. However, IRS has stated at many employee benefit conferences that use of the rollover process is the IRS' preferred method of dealing with the accounts of missing participants under terminated defined contribution plans.
• Title I of ERISA issues. The IRS notes in the ruling that DOL would treat the choice of the IRA trustee, custodian, or issuer as a fiduciary action. However, once the funds are rolled over to the IRA, the distributee is no longer a participant under the plan for Title I purposes, because the entire benefit has been paid from the plan. See the definition of participant in DOL Reg. §2510.3-3(d).
• Default rollover may not occur before end of 30-day election period. Remember that Treas. Reg. §1.402(f)-1, Q&A-2, requires the §402(f) notice to be provided no less than 30 days before the distribution. Thus, the participant must be given at least 30 days to make an affirmative election between the cash distribution and the direct rollover. Only after the expiration of this minimum election period may the plan proceed with the default rollover.

In applying the same desk rule, it is not relevant whether a transferred employee performs different services and job functions than he performed for former employer if such change occurs after the date the employee is transferred to the new employer (added July 18, 2000). In PLR 200027059, the IRS specifically addresses the affect of a later change in a transferred employee's job functions on the determination of whether there has been a separation from service with the prior employer. This case is another one where there is no sale of assets, stock, merger or other business transaction between the former employer and the new employer. However, the transferred employees, at least initially, continue to perform the same job functions that they performed for the former employer. The 342 employees at issue here were performing information services for Corporation A. A determined that it needed to concentrate on other business operations, so it decided to outsource the information services component of its operations. The outsourcing occurred under a contract with Corporation C, an unrelated company. The contract was effective March 1, 1999. As of that date, the 342 employees were terminated from A's employees and were hired by C. Corporation C determined that the required level of staffing under its contract with A required no more than 300 of these 342 employees. C initially had all 342 employed to carry out the functions of the contract with C, but by October 1, 1999, there had been substantial changes. Only about 100 of the 342 employees will continue to perform services for A on-site. The rest work in other facilities, some performing services for A only part of the time and others no longer providing services for A. A maintains a 401(k) plan. Rulings were requested on whether any of the following employees could be treated as having a separation from service with A, thereby triggering a distribution event from the 401(k) plan: 1) those whose supervisors, benefits, or policies had changed, but who continued to perform services for A under Corporation C's contract with A, 2) employees who, on some date after their initial hire by C, work exclusively on non-A work, 3) employees who, on some date after their initial hire by C, work at least part of the time on non-A work.

• The IRS ruled that none of these employees has a separation from service. When there is no business transaction (e.g., sale of assets or stock) that involves the transfer of employees, IRS looks at the job functions of the transferred employes to determine whether the same desk rule applies with respect to the former employer. If, at the time of transfer, the employees continue to perform services for the former employer in substantially the same job capacities, the same desk rule is triggered and there is no separation from service with the former employer. Any later changes to the job functions of the transferred employees are irrelevant in finding a separation from service, so long as the employees continue to work with the company who initially hired them from the former employees. Thus, all three categories of employees described in the prior paragraph do not have a separation from service with A, even if they no longer perform any services under C's contract with A or work only part of the time under such contract. So long as these employees continue to work for C, the A 401(k) plan may not treat them as having a separation from service.

Interest rate not exceeding 120% of federal mid-term rate is deemed reasonable for calculating "substantially equal" payments under IRC §72(t)(2) exception (added July 18, 2000) In PLR 200027062, the taxpayer, who is age 53, elected substantially equal payments to be made from his IRA. The payments are intended to be exempt from the premature distribution penalty, pursuant to IRC §72(t)(2)(A)(iv). The monthly payments were calculated on the basis of the taxpayer's IRA account balance as of November 30, 1999, using A's life expectancy (30.4 years) under Table V in Treas. Reg. §1.72-9, and an interest rate assumption of 6%. This is the amortization method prescibed by Notice 89-25. In past rulings, IRS has said that the interest rate used to calculate substantially equal payments must be reasonable, but has not established any safe harbor standard. In this ruling, the IRS takes the position that any interest rate which does not exceed 120% of the federal mid-term rate is treated as reasonable.

Rollover of non-employer-stock investments to money purchase plan established solely to accept rollovers does not preclude exclusion of NUA on employer stock distributed from KSOP (added July 18, 2000) In PLR 200027058, Plan X includes a 401(k) arrangement and an ESOP (referred to as a "KSOP" in this discussion). Employer contributions are invested in employer stock. Employees have several investment choices for their 401(k) contributions. Plan Y, a money purchase plan, was established solely for the purpose of accepting rollovers. The employer contribution formula is 0%. The only eligible employees for Plan Y are: 1) employees who have attained age 59-1/2 and have received a lump sum distribution from Plan X, and 2) former employees who receive a lump sum distribution from Plan X. The purpose of Plan Y is to provide a means for these employees and former employees to accomplish two goals: 1) retain the portion of their lump sum distribution that consists of employer securities, in order to take advantage of the gross income exclusion for net unrealized appreciation (NUA), and 2) continue the remaining investment of their account in the same investment options they had under Plan X.

IRC §402(e)(4) provides that, in the case of a lump sum distribution which includes employer securities, NUA on those securities is excluded from the distributee's gross income unless otherwise elected. In several previous private letter rulings, the IRS has ruled that, although a partial rollover precludes income averaging treatment on a lump sum distribution, it does not affect the right to the NUA exclusion for the emploiyer securities that are not rolled over. Thus, when an employee or former employee who is eligible for Plan Y rolls over the non-employer-securities to Plan Y, the remaining distribution from Plan X is eligible for the NUA exclusion. In other words, the combination of the distribution of the employer securities from Plan X and the direct rollover of the remaining investments to Plan Y, constitute a lump sum distribution for §402(e)(4) purposes, allowing the NUA exclusion on the distributed employer securities. By establishing Plan Y, the employer has provided a means for these participants to preserve the current non-stock investments in their accounts, through the rollover to Plan Y, while electing a distribution of the employer securities and taking advantage of the NUA exclusion.

An interesting sidenote with this case is the establishment of Plan Y with no employer contribution formula. Is it significant that Plan Y is a money purchase plan and not a profit sharing plan? It seems so. Questions have been raised at various employee benefit conferences whether a profit sharing plan can be established solely for the purpose of accepting rollovers. Treas. Reg. §1.401-1(b)(2) requires an employer to make "substantial" and "recurring" contributions to a profit sharing plan. No parallel requirement exists for money purchase plans. Thus, by establishing Plan Y as a money purchase plan, the fact that the plan is funded solely with rollovers from Plan X does not present a problem.

Automatic enrollment feature is permissible in 403(b) plan/caution on Title I issue (added July 18, 2000) Rev. Rul. 2000-35 confirms that an automatic enrollment feature is acceptable under a section 403(b) plan. This is true regardless of whether the plan is funded with annuity contracts or custodial accounts. The requirements parallel those prescribed for 401(k) plans under Rev. Rul. 2000-8. If the automatic enrollment feature is properly applied, the contirubtions deducted from an employee's compensation, for transmittal to the 403(b) plan, are treated as salary reduciton contributions that are excludable from income (subject to the §402(g) limit, the maximum exclusion allowance under IRC §403(b), and the section 415 limits).

• Caution - Title I issue. If a 403(b) plan is set up solely to receive salary reduction contributions, and no employer contributions will be made to the plan (i.e., no matching contributions and no nonelective contributions), the plan is generally exempt from Title I of ERISA. See DOL Reg. §2510.3-2(f). However, one of the conditions for the Title I exemption is that the employer have limited involvement in the plan. Included in the activities the employer may engage in without creating a Title I plan is the collection of contributions through the salary reduction agreements and transmital of those contributions to the annuity provider or custodian of the custodial account. Is an automatic enrollment program crossing the line, resulting in Title I coverage? This issue is not addressed in Rev. Rul. 2000-35, because the employer makes matching contributions under the plan, resulting in Title I coverage anyway. Perhaps the IRS or DOL will clarify this issue at a later date.

Other news. The capsules which appear after this paragraph are discussed (often in more detail) in the Summer 2000 Issue of ERISA Views (published July 17, 2000).

IRS issues extension of GUST remedial amendment period (added June 20, 2000). Rev. Proc. 2000-27 extends the GUST remedial amendment period to the end of the plan's 2001 plan year. For calendar year plans, that means a deadline of December 31, 2001. For noncalendar year plans, the 2001 plan year is the plan year which begins in 2001. For example, a plan with a June 30 plan year would have its GUST remedial amendment period extended through June 30, 2002, because that is the end of the plan year which starts in 2001.

• Applicable to adopters of M&P plans and volume submitter plans, too. The extension to the end of the 2001 plan year applies to all plans, including plans adopted on a master/prototype plan (M&P plan) or on a volume submitter plan. However, M&P plan and volume submitter plan might have even longer to amend because of Rev. Proc. 2000-20. Under Rev. Proc. 2000-20, an employer will have a deadline which ends no earlier than 12 months after the IRS issues its GUST opinion letter for an M&P plan or its GUST advisory letter on a volume submitter plan. For example, if the GUST opinion letter for an M&P plan were issued in June 2001, the 12-month period would end June 30, 2002. An employer who qualifies for the 12-month period under Rev. Proc. 2000-20 will have to amend its plan for GUST by the later of: 1) the last day of the 2001 plan year, or 2) 12 months after the month in which the M&P plan's opinion letter or volume submitter plan's notification letter is issued. One of the conditions to qualify for the 12-month period under Rev. Proc. 2000-20, is that by the end of the normal GUST remedial amendment period, the employer either must be an adopter of an M&P plan or volume submitter plan, or have certified with an M&P sponsor or a volume submitter sponsor that it intends to adopt that sponsor's M&P plan or volume submitter plan to amend for GUST. Thus, the extension of the normal GUST remedial amendment period to the end of the 2001 plan year also extends the deadline for meeting this condition for qualifying for the 12-month period under Rev. Proc. 2000-20.
• No extension for submitting M&P plans and volume submitter plans under Rev. Proc. 2000-20.The extension of the normal GUST remedial amendment period does not extend the December 31, 2000, deadline under Rev. Proc. 2000-20 for an M&P sponsor to submit its M&P plan for a GUST opinion letter or for a volume submitter sponsor to submit its volume submitter plan for a GUST advisory letter in order to obtain the special 12-month amendment period for adopting employers. If the opinion letter or advisory letter application is not submitted by December 31, 2000, the M&P sponsor or volume submitter sponsor will not be able to offer the 12-month amendment period under Rev. Proc. 2000-20. The clients of that sponsor would then have to make sure GUST amendments were adopted by the end of the 2001 plan year.

Opening of determination letter for full GUST approval; three categories of determination letters can be requested regarding the scope of review; full restatement of plan generally required (added June 20, 2000) In addition to extending the GUST remedial amendment period (see above report), Rev. Proc. 2000-27 fully opens the IRS' determination letter program for GUST. Rev. Proc. 2000-27 refers to three categories of determination letters: (1) GUST II letter: Determination letter which considers all GUST changes, including those first effective in post-1998 plan years; (2) GUST I letter: Determination letter which takes into account all GUST changes except those made by the SBJPA which are first effective in post-1998 plan years; and (3) Pre-GATT letter: Determination letter that does not take into account any of the GUST changes except those made to IRC §401(a)(26) (i.e., repeal of §401(a)(26) requirement for defined contribution plans and modification of the 40% test for defined benefit plans) and to IRC §414(n) (change in the definition of leased employees). Prior to the issuance of Rev. Proc. 2000-27, GUST II letters were available only for terminated plans. With the issuance of Rev. Proc. 2000-27, GUST II letters are now available to plans which are not terminated. Determination letters that were filed before June 26, 2000 (i.e., the effective date of Rev. Proc. 2000-27), either had to request a GUST I letter or a pre-GATT letter. See Rev. Proc. 98-14, as modified by Rev. Proc. 98-53. If a pre-June 26, 2000, application is still pending, it may be converted into an application for a GUST II letter (see section 3.06 of Rev. Proc. 2000-27).

• Application procedures for individually-designed plans (including volume submitter plans). If a determination letter is applied for on an individually-designed plan, including a volume submitter plan, on or after June 26, 2000, the scope of the review will be for a GUST II letter unless otherwise requested. Until further notice, the applicant may request a GUST I letter or a pre-GATT letter instead. Why might a GUST I letter or a pre-GATT letter be requested? (1) The plan might be submitted for a determination letter on a plan amendment, for which the employer would like immediate IRS review, but the employer is not ready to have the plan fully reviewed for a GUST II letter. (2) The employer has signed a written certification with an M&P sponsor or volume submitter practitioner, pursuant to Rev. Proc. 2000-20, that it will amend its individually-designed plan for GUST by using the M&P plan or volume submitter plan. The M&P plan or volume submitter plan is not GUST-approved yet but, in the interim, the employer has adopted some amendments to its individually-designed plan for which it would like immediate review. (3) The plan is an initial adoption of a volume submitter plan, but the volume submitter plan has not been amended for GUST. The employer would like a determination letter on its adoption of the plan before the volume submitter plan has been amended for GUST. (4) The employer wants to wait until the finalization of the proposed regulations under IRC §411(d)(6) that were published on March 29, 2000, before a GUST II letter is requested. See the discussion of the §411(d)(6) regulations later in this summary. Note that, under (1), (2) and (3), the GUST remedial amendment period applies to non-GUST amendments and to new plans as well. Thus, in many cases, the employer would not be requesting a determination letter on a plan amendment, in the case of (1) or (2), or on the initial adoption of a plan, in the case of (3), before it is ready to submit for a GUST II letter. However, in some cases, because of concerns about the acceptability of a plan amendment, or a plan provision in a newly-adopted plan, particularly one that might affect benefit accruals, or how the plan is tested for nondiscrimination compliance, an employer might want an IRS determination on the initial adoption of the plan, or on an amendment to the plan, before the plan is properly amended to obtain a GUST II letter.
• Application procedures for adopters of M&P plans. If the plan being submitted is an adoption of an M&P plan (which includes a pre-GATT regional prototype plan), the plan is not reviewed for a GUST II letter if the M&P plan has not been issued a GUST opinion letter under Rev. Proc. 2000-20, unless the plan is terminated. Thus, when a determination letter is requested by the adopting employer of an M&P plan that has not received a GUST opinion letter under Rev. Proc. 2000-20, the determination letter will reflect the same scope of review as the underlying M&P plan. If the M&P plan has not had any review for GUST, the determination letter will be a pre-GATT letter. If the M&P plan received a GUST opinion letter, pursuant to Rev. Proc. 98-14, which is analogous to a GUST I letter, but has not received a GUST opinion letter under Rev. Proc. 2000-20, the determination letter issued to the adopting employer will be a GUST I letter. When an M&P plan obtains its GUST opinion letter under Rev. Proc. 2000-20, then the adopting employers of that M&P plan will receive determination letters that are GUST II letters.
• Complete restatement generally required. In general, plans must be restated when they are submitted for GUST II letters under Rev. Proc. 2000-27. However, section 3.04 of Rev. Proc. 2000-27 provides that an amendment, rather than a restated plan, may be submitted instead if all of the following requirements are satisfied: (1) The plan has had fewer than four consecutive amendments since it was last restated (excluding amendments which make only nonsubstantive changes), (2) The plan has a favorable TRA ‘86 determination letter, and (3) One of the following two conditions are met: a) the plan is a defined contribution plan under which the only contributions are nonelective employer contributions (i.e., no 401(k) arrangement, no matching contributions, and no after-tax employee contributions), or b) the plan has a favorable GUST I letter and is not adding provisions relating to the ADP safe harbor under IRC §401(k)(12) nor the ACP safe harbor under IRC §401(m)(11). (If the plan accepts rollovers, that would not cause the plan to fail to satisfy this third requirement.)
• Application form to submit for GUST II letters. Generally, the application form is a Form 5300 (individually-designed plan) or Form 5307 (volume submitter plan or M&P plan adopter) to obtain a favorable GUST II letter. However, Form 6406 may be used by a defined contribution plan that already has a favorable GUST I letter and is not adding provisions relating to the ADP safe harbor under IRC §401(k)(12) nor the ACP safe harbor under IRC §401(m)(11). See section 3.05 of Rev. Proc. 2000-27.
• Amendments to the §411(d)(6) regulations. On March 29, 2000, the Treasury proposed amendments to the §411(d)(6) regulations which will allow defined contribution plans to eliminate certain optional forms of benefit without violating the anti-cutback rule. However, these amendments may not be adopted until regulations are finalized. If a GUST II letter is issued before these regulations are finalized, the employer would have to submit for another determination letter (and pay another user fee) to obtain reliance on plan amendments adopted to reflect such regulations. If the employer is intending to make amendments to its plan once these regulations are issued, it may want to postpone its request for a GUST II letter. If the only purpose of obtaining the determination letter is to receive a favorable GUST II letter, then the employer should simply wait to file until after the §411(d)(6) regulations are amended. The Treasury intends to finalize those amendments well before the GUST remedial amendment period is scheduled to expire. If the employer is desiring a determination letter at this time anyway, but would like its GUST II letter to cover the amendments to the §411(d)(6) regulations to be issued in the future, the employer should request either a pre-GATT letter or a GUST I letter, so the IRS is not fully reviewing the plan for GUST as part of the determination letter request. See the earlier discussion in this summary.

Plans granted some transition relief in applying rollover rules to hardship withdrawals from 401(k) and 403(b) plans, but January 1, 2000, effective date is not delayed (added June 8, 2000). Responding to public comments, the IRS has granted some relief on the application of the rollover rules to hardship distributions of 401(k) contributions and to hardship withdrawals from section 403(b) plans. The IRS Restructuring and Reform Act of 1998 ("RRA 98") added IRC §402(c)(4), which prohibits the rollover of 401(k) contributions distributed on account of hardship. Similar rules were adopted for section 403(b) plans. The RRA 98 amendment was effective January 1, 1999, but Notice 99-5 postponed the mandatory effective date to January 1, 2000 (although a plan was permitted to be administered in accordance with the new rules for distributions made in 1999). Now comes Notice 2000-32. This notice does not further delay the effective date of these new rules, but provides some transition relief pending the issuance of later guidance. Thus, hardship withdrawals made from 401(k) plans or 403(b) plans during 2000 and in later years must follow the RRA ‘98 requirements, except as relief is provided in Notice 2000-32. Notice 2000-32 addresses the following issues.

• Amounts subject to rollover limitations. Under a 401(k) plan, the only amounts subject to the new rollover limitations are elective contributions under the 401(k) arrangement ("401(k) contributions") plus "pre-‘89 401(k) amounts." For this purpose "pre-‘89 401(k) amounts" means qualified nonelective contributions (QNECs), qualified matching contributions (QMACs) and earnings on 401(k) contributions, QNECs and QMACs credited as of date specified in the plan (but no later than July 1, 1989). Many sponsors commented to IRS that plan records are not able to distinguish between pre-‘89 401(k) amounts" and other amounts (e.g., profit sharing contributions that are not QNECs or matching contributions that are not QMACs) credited as of the 1989 date. If this is the case, then the other pre-89 amounts, which might also be eligible for hardship withdrawal, will be subject to the same rollover limitations as the 401(k) contributions (i.e., they will be ineligible for rollover if withdrawn on account of hardship). This relief applies only if the plan's records are not "reasonably available" to segregate an employee's pre-‘89 401(k) amounts from other amounts that, as of the 1989 date, were credited to the employee's account.
• Relief on situations where participant satisfies another statutory distribution event. Under Notice 99-5, the IRS provided that if, at the time of the hardship withdrawal, a participant satisfies another statutory distribution event under IRC §401(k), that the hardship withdrawal is eligible for rollover, even if it consists of 401(k) contributions, and even if the plan does not provide for distribution on account of that other statutory distribution event. For example, if a participant is age 62 when she requests the hardship withdrawal, the hardship withdrawal is eligible for rollover, even the amount consisting of 401(k) contributions, because age 59½ is a statutory distribution event. This is true even if the plan does not provide for the age 59½ distribution event. Under Notice 2000-32, the plan may ignore this rule, until further guidance is issued. If the rule is ignored then the amount of the hardship withdrawal attributable to 401(k) contributions would be treated as ineligible for rollover, even if the participant has reached age 59½. The same relief applies to section 403(b) plans.
• Allocation of basis. Notice 99-5 required the portion of the distribution that is not includible in gross income (i.e., the return of basis portion) to be allocated first to the portion of the distribution that is ineligible for rollover (i.e., the hardship distribution attributable to the 401(k) contributions). Until further guidance is issued, Notice 2000-32 permits the plan to adopt any other reasonable alternative method. For example, the plan could allocate the basis to the portion of the distribution that is eligible for rollover (which would reduce the amount the participant could actually roll over) or to apportion the basis between the amount which is ineligible for rollover and the amount which is eligible for rollover.

IRS informally accepting voluntary correction requests for SEPs (added June 1, 2000). Speaking today at an employee benefits conference sponsored by the Cincinnati Bar Association, Joyce Kahn of the IRS said that there are plans to expand the voluntary correction programs under EPRCS to include simplified employee pension plans (SEPs). In the meantime, however, IRS is accepting informal requests for voluntary correction of operational violations by SEP sponsors. For these cases, the IRS has been using the fee structure published in Rev. Proc. 2000-16 for VCR applications. For most SEPs the fee works out to be $500. When the program is expanded to formally include SEPs this is the most likely fee structure that will be adopted.

IRS emphasizes any changes to new comparability rules will be prosective (added June 1, 2000). Speaking today at an employee benefits conference sponsored by the Cincinnati Bar Association, Dick Wickersham of the IRS addressed Notice 2000-14, which announced that IRS was studying new comparability plans with an eye toward possible revision of the nondiscrimination testing rules applicable to these plans. (Notice 2000-14 is discussed in detail later in this "What's New" section.) Mr. Wickersham emphasized that if any changes are adopted, they would be prospective only and that "prospective" would likely mean plan years which begin after the date proposed regulations are published. More importantly, until such rules are published and become effective, these plans are perfectly okay and the present regulations continue to apply, even for new plans being established and for existing plans being converted after the publication of Notice 2000-14. Mr. Wickersham also discussed the 2002 effective date relief for certain plans (see later discussion of Notice 2000-14 for details). The 2002 effective date relief was not intended to mean that plans which couldn't qualify for that relief might have retroactive exposure. The effective date relief simply meant that, if the plan qualified for that relief, its prospective effective date for new rules would be no earlier than the 2002 plan year. For other plans, the effective date could be earlier, but in no event will the effective date be retroactive. Since we are almost halfway through 2000, and Mr. Wickersham did not see the publication of proposed regulations to be "imminent," he felt that it is unlikely that any prospective effective date would affect plan years starting before January 1, 2001. He also noted that a large volume of comments were received, and some valid points in favor of preserving the current rules were made.

Two recent "same desk" rule private letter rulings (added May 26, 2000). In two recent private letter rulings, the IRS has had to rule whether the "same desk" rule applied in determining whether certain employees had separated from service for 401(k) purposes. The rulings underscore how confusing this determination can be and how nuanced the IRS' analysis is.

• In PLR 200019048, fired employees who were hired by a contractor to perform the same services for their former employer did not have separation from service under a 401(k) plan because of the same desk rule. Company O decided to no longer perform its own data processing services. It contracted with Company P to perform these services. O then fired the employees who performed these services and paid them severance. Although under no formal agreement to do so, P hired these employees to perform the same data processing services they performed as employees of O. However, now they perform these services as employees of P. In addition, these services continue to be performed on the same premises. The IRS determined that O's former data processing employees who were hired by P, and continue to perform such services under P's contract with O, do not have a separation from service under IRC §401(k)(2) because of the same desk rule, as prescribed by Rev. Rul. 79-336. Therefore, O's 401(k) plan may not make separation-from-service distributions to these employees.
• In PLR 200019045, Employees who were discharged due to the termination of a joint agreement had a separation from service even though the discharged employees were hired by a separate company to perform similar functions under new joint agreement. Company A entered into a joint agreement with Company C to perform certain functions. Company A employs "Group D" employees to handle legal claims and to provide legal advice relating to the joint agreement. In 1998, the joint agreement was terminated, and A no longer needed the Group D employees. The Group D employees were discharged effective December 31, 1998. On January 1, 1999, the Group D employees were hired by Company B. B is unrelated to A. Company B is now in a similar joint agreement with C and the Group D employees were hired by B to perform the same functions (i.e., legal services) as they performed while working for A. The IRS determined that the same desk rule under Rev. Rul. 79-336 is not applicable here because the transfer is not a business transaction (liquidation, merger, consolidation, sale of assets) between A and B, and A and B always have been and remain separate and distinct unrelated companies. Thus, Company A's 401(k) plan may make distribution to the discharged Group D employees on account of separation from service within the meaning of IRC §401(k)(2). Compare this ruling to the one in PLR 200019048 (discussed in the prior paragraph). In PLR 200019048 there was also no business transaction, as described in Rev. Rul. 79-336. However, the discharged employees continued to perform services for the company that maintained the 401(k) plan, because they were hired by a separate firm contracted by the 401(k) plan sponsor to perform the same services they performed prior to their discharge. Where a merger, sale, liquidation, or other business transaction is not present, IRS seems to focus on whether a continuing business relationship exists between the former employer and the new employer after the discharge of the employees which will result in the former employees performing the same (or substantially similar) services for the former employer. If such a continuing business relationship exists, the same desk rule will preclude a finding of separation from service.

Preemptive exclusion of independent contractors who might be retroactively reclassified as employees, and exclusion of certain employees on special or limited work assignments identified by certain payroll codes, are permissible exclusion categories under IRC §410(a) and do not violate definite written program requirement (added May 26, 2000). These issues were addressed in an Unnumbered Technical Advice Memorandum, dated July 28, 1999, which was reprinted in BNA Pension & Benefits Reporter, 5-2-00 issue, page 1161. The TAM addresses whether a plan's eligibility exclusion classifications are acceptable eligibility conditions under IRC §410(a) and whether the classifications violate the requirement under Treas. Reg. §1.401-1(a)(2) to have a definite written program. The plan contains two participation exclusion categories.

• Independent contractors. The plan specifically provided for an exclusion of independent contractors, even though independent contractors are not permitted to participate in an employer's plan anyway. The purpose of the exclusion was to clarify that retroactive rights to participation would not trigger if the independent contractor were to be reclassified as an employee. To this end, the plan's exclusion provided that if an individual was not reported on the company's payroll records as a common law employee, the employee would be ineligible for the plan during such period of classification as an independent contractor even if a court or administrative agency (e.g, IRS) later determines that such individual was a common law employee for all or a portion of that period. The purpose of this exclusion was to address the issue in the Microsoft case (sometimes referred to as Microsoft-proofing the plan), where independent contractors retroactively reclassified as employees are claiming make-up benefits under the Microsoft plan. By having this exclusion, the employer avoids having retroactive benefit liabilities merely because an independent contractor is later reclassified as an employee on a retroactive basis.
• Special assignment employees. These employees were defined as workers who were listed under two specific job codes on the company's payroll records. One code was for workers hired to perform work on specific contracts with specific deadlines for specific operation and benefits. The specified benefits included participation in other retirement plans. The other code was for laid-off union workers who were hired for a predetermined period of time to complete a specific task or project.

IRS relaxes "same desk" rule for 401(k) distributions following an acquisition of part of a company's assets (added May 8, 2000). In a partial retreat from the same desk rule described in Rev. Rul. 79-336, the IRS has relaxed the rule to determine whether an employee has a separation from service for 401(k) purposes when his employment is transferred pursuant to an acquisition of a portion of the company's assets. The new rule is set forth in Rev. Rul. 2000-27. Under the same desk rule, when an employee's employment is transferred to another company pursuant to an asset acquisition, the employee is not treated as having a separation from service if he continues to work with the acquiring company in substantially the same job that he had with his prior employer. Rev. Rul. 79-336 was issued for purposes of determing whether a separation from service had occurred in order to elect income averaging treatment on a lump sum distribution. However, IRS has applied the same principles anywhere the term "separation from service" is used in the tax code. IRC §401(k)(2) is one of those places where the term "separation from service" is used. When a company sells substantially all of its assets (defined by the Treasury to mean at least 85% of assets), an exception to the same desk rule under IRC §401(k)(10) allows distribution to an employee whose employment is transferred to the purchaser, provided that the purchaser does not continue the seller's plan. However §401(k)(10) is available only if at least 85% of the assets are sold and only corporations can qualify for this distribution event (i.e., both the seller and the buyer have to be corporations). Now comes Rev. Rul. 2000-27, which will give the green light for distribution from the seller's plan where the §401(k)(10) event is not satisfied. Rev. Rul. 2000-27 treats the transferred employees, when substantially all the assets of a trade or business are not being sold, to have had a separation from service for §401(k)(2) purposes, provided the purchaser does not take over sponsorship of the seller's plan. This rule applies regardless of whether the companies are corporations, and regardless of whether the purchaser hires the transferred employees pursuant to a contractual obligation. That fact that some or all of the transferred employees directly rollover their distributions to the purchaser's plan does not cause the purchaser to be considered as having assumed sponsorship of the seller's plan.

• One cautionary note: the ruling says that it applies only when less than substantially all the assets of a trade or business are sold. In some cases, the sale of substantially all the assets of a trade or business will not satisfy IRC §401(k)(10) (e.g., when a noncorporate entity is the seller or buyer). It would seem that the transferred employees in those sales should be entitled to the same relief as the transferred employees in the partial sales described in Rev. Rul. 2000-27. Maybe IRS will clarify this point at a later date. IRS might not feel it has the statutory authority to permit distribution when substantially all the assets of a trade or business are being sold but the transaction fails to satisfy all the requirements of §401(k)(10).

• IRS recognizes that many practitioners have relied on the same desk rule to conclude that transferred employees do not have a separation from service, and thus are not entitled to a distribution, under asset sales described in Rev. Rul. 2000-27. With respect to any sale described in Rev. Rul. 2000-27 which occurs before September 1, 2000, the IRS will NOT treat the plan as failing to properly apply the separation from service event under §401(k)(2) merely because it does not treat the transferred employees as having a separation from service.

Small plans must issue SARs every year now (added April 22, 2000). The DOL has finalized amendments to its regulations to incorporate the revisions to the Form 5500 series. One of the revisions is the elimination of Form 5500-C/R. Prior to the amendment, DOL Regulation section 2520.104b-10 prescribed an alternative method for satisfying the summary annual report (SAR) requirement for years in which a Form 5500-R was filed. Under the alternative method, the plan could provide the participants a copy of the Form 5500-R, or post a notice at the worksite which described each participant's right to obtain a copy of the Form 5500-R. This allowed a small-plan filer to limit preparation and furnishing of a separate SAR to every third year, when the Form 5500-C was filed. Since the revised forms eliminate Form 5500-C/R, this alternative method for complying with the SAR requirement no longer applies to reports filed for the 1999 plan year and subsequent plan years. Thus, small-plan filers now have an annual requirement to prepare a separate SAR and to furnish the SAR to the participants and beneficiaries.

Protecting qualification of recipient plan of an invalid rollover; administrator must reasonably conclude distributing plan is qualified; evidence of determination letter not required (added April 22, 2000). The Treasury has added new Q&A-14 to Treasury Regulation section 1.401(a)(31)-1 (and renumbered Q&A-14 through Q&A-18 as Q&A-15 through Q&A-19). Q&A-14 provides relief to a plan ("recipient plan") which receives a defective rollover. For relief to apply, the administrator of the recipient plan must reasonably conclude that the distributing plan is a qualified plan. The regulation was originally proposed in 1996, but amended in 1998 to clarify that evidence of a determination letter on the distributing plan is not required to reasonably conclude that the distributing plan is qualified. The final regulation does not make any substantive changes to the proposal. The regulation provides four examples of what kinds of information a recipient plan might use to reasonably conclude the distributing plan is qualified, depending on whether the rollover is a direct rollover or a rollover contributed by the participant.

• In a direct rollover transaction, a letter from the distributing plan is provided to the recipient plan which states that the distributing plan has received a determination letter (a copy of that letter need not be requested for the plan administrator to be considered to have acted reasonably). This is Example 1 in the regulation.
• In a direct rollover transaction, a letter from the distributing plan is provided to the recipient plan which states that the distributing plan satisfies the requirements of IRC §401(a) (or that the plan is intended to satisfy the requirements of §401(a) and the administrator is not aware of any provision or operation that would result in the disqualification of the plan). This is Example 2 in the regulation.
• When the contribution is received from the participant, after the participant accepts distribution from a qualified plan, a certification is obtained from the participant that, to the best of his or her knowledge, a) he or she was entitled to the distribution as an employee, not as a beneficiary, b) the distribution was not one of a series of periodic payments, c) the distribution was received not more than 60 days before the date of the rollover contribution, and e) the entire amount being rolled over would be includible in the employee's income if it were not being rolled over. The example also notes that the employee provides the plan administrator a copy of his distribution statement that accompanied the distribution check. For example, a statement indicating 20% withholding would indicate the distributing plan had determined the distribution was an eligible rollover distribution. This is Example 3 in the regulation.
• Where the rollover contribution is from a conduit IRA, the participant's certification described in the the prior paragraph also should include a statement that the contribution to the conduit IRA was made not more than 60 days after the employee had received payment from the distributing plan, no amounts other than distributions from qualified plans were contributed to the conduit IRA, and the distribution from the conduit IRA was made not more than 60 days before the rollover contribution to the recipient plan. To support the certification, the plan administrator might request statements from the IRA that indicate when it was established, and that show an opening balance that does not exceed the amount shown on other statements that support the amount of qualified plan distributions that were rolled over into the IRA. Any statement received from the IRA should not have any indication that additional contributions were made to the IRA. This is Example 4 in the regulation.

Non-spouse beneficiaries may not rollover inherited traditional IRA to Roth IRA (added April 15, 2000). By reason of a disclaimer, the children of the deceased IRA owner of a traditional IRA became the beneficiaries of that IRA. In the eighth of eight ruling requests made in PLR 200014041, the beneficiaries requested a ruling that they could convert the IRA to a Roth IRA, pursuant to IRC §408A(d)(3). IRC §408A(e) permits conversion treatment only for qualified rollover contributions. Non-spouse beneficiaries are not permitted to rollover an inherited IRA. See IRC §408(d)(3)(C). Therefore, a conversion to a Roth IRA is not available.

Treasury proposes to expand the circumstances under which certain optional forms of benefit may be eliminated and to relax elective transfer rules (added March 29, 2000). The Treasury has published proposed amendments to Treas. Reg. §1.411(d)-4 that would relax some of the requirements under IRC §411(d)(6) to protect optional forms of benefit. The proposal would allow: 1) defined contribution plans to eliminate certain periodic payment options, such as an annuity or installment distribution, 2) defined contribution plans to eliminate certain in-kind distribution options, 3) defined benefit plans to replace the right to take an annuity distribution in the form of an annuity contract with the payment of that annuity in cash, and 4) relax the elective transfer rules. These changes would not be effective until after the publication of final regulations. In addition, plan sponsors may not implement these proposals prior to the publication of final regulations. If the regulations are adopted as proposed, employers will have more flexibility with respect to plan design decisions relating to optional forms of benefit. Here are some highlights.

• Elimination of QJSA in non-pension plan. A non-pension plan (e.g., profit sharing plan) that is currently required to offer life annuity options and, thus, must comply with the qualified joint and survivor annuity requirements (QJSA) under IRC §417, would be able to eliminate the QJSA by discontinuing annuity options, so long as a single-sum distribution and an installment distribution option based on life expectancy periods. These rules would not override the QJSA rules for plans which are required by statute to comply with them. For example, a pension plan (e.g., money purchase plan) could not be amended to eliminate the QJSA. Also, a non-pension plan which is a transferee of a money purchase plan, as described in IRC §401(a)(11)(B)(iii)(III), would not be permitted to eliminate the QJSA option, at least with respect to the transferred benefits.
• Reduction of multiple periodic payment options. A defined contribution plan that has two or more periodic payment options (e.g., annuity options, installment options) due to a merger with another plan or the adoption of a different prototype or volume submitter document, could reduce the number of extended payment options to as few as one, so long as a single-sum option is also available and certain other conditions are satisfied.
• Elective transfers between DC plans of benefits that are not immediately distributable. A defined contribution plan could allow a participant to elect to have his benefit transferred to another defined contribution plan in an elective transfer transaction prior to the time his benefit is immediately distributable under the transferor plan. The transferee plan would not have to protect the optional forms of benefit that were available under the transferor plan. This option would be restricted to situations where the participant has another option that would protect the optional forms of benefit in the transferor plan (e.g., retention of the benefits in the transferor plan).
• Elimination of in-kind distributions in marketable securities. A defined contribution plan that permits employees to receive distributions in-kind (e.g., distributions of specific investments in a participant-directed account) could be amended to require such distributions attributable to the marketable securities be made in cash.
• Limitation of in-kind distributions to investments at time of distribution. A defined contribution plan that permits employees to receive distributions in-kind could be amended to limit the available in-kind distributions to the investments held by the participant's account at the time distribution is elected. Such a rule would provide plans more flexibility to change investment options. For example, if a profit sharing plan allows distribution in the form of employer securities, but at the time of distribution, the participant's account does not have any investments in employer securities because the employer has discontinued the option to invest in employer securities, the participant would not have to be allowed to request distribution in the form of employer securities.

Automatic extension for 1999 Form 5500 filings due on or before July 31, 2000 (added March 24, 2000). To ease the transition to the new Form 5500 Series under the new ERISA Filing Acceptance System (EFAST), the IRS, DOL and PBGC issued a joint news release to extend 1999 returns due on or before July 31, 2000. The extension is to October 16, 2000. Since that extension coincides with the maximum extension allowed to a return due on July 31, 2000, no further extension may be obtained by filing Form 5558. However, the Form 5558 does not have to be filed to obtain the extension granted by the press release. The extension only applies to: 1) a plan whose 1999 plan year is on a calendar year, 2) or a terminated noncalendar year plan that completed final distribution of assets before January 1, 2000, because only those plans have a 1999 return due on or before July 31, 2000. For other plans, the 1999 return is due after July 31, 2000. Therefore, those plans are not covered by the automatic extension granted by this news release.

IRS clarifies prospective effective date guidelines if new rules for new comparability plans are adopted (added March 24, 2000; modified March 29, 2000). In Notice 2000-14 (see summary later in this What's New section), the IRS announced it was re-examining new comparability plans and contemplating the issuance of new rules that would affect that manner in which these plans satisfy the section 401(a)(4) nondiscrimination requirements. In comments published in the March 23, 2000, Daily Tax Report, the Treasury has assured sponsors that certain existing and new plans which use new comparability formulas will not have to satisfy any new requirements earlier than the first plan year beginning on or after January 1, 2002 (i.e., the 2002 plan year). To have protection until the 2002 plan year, the plan must fall into one of three categories.

• Category #1 - existing plans already with new comparability formulas. A plan falls into this category if it already has a new comparability formula. The Treasury is purportedly using the February 24, 2000, publication date of Notice 2000-14 as the cutoff date to determine whether an existing plan already has a new comparability formula.
• Category #2 - conversion of plan that provides for elective deferrals and matching contributions only. An existing plan which is not described in Category #1 may be amended to provide for new comparability, and have protection until the 2002 plan year, if the employer contributions currently made to the plan are attributable only to elective deferrals under a section 401(k) arrangement, or only to elective deferrals and matching contributions.
• Category #3 - certain new plans adopted with new comparability formulas. A new plan falls into this category if it is a new plan adopted after the publication of Notice 2000-14, with a new comparability formula, but only if the employer does not currently maintain a plan, or the only plan maintained by the employer is a plan described in Category #2, a SEP or a SIMPLE plan.

DOL issues voluntary fiduciary correction program (added March 15, 2000). DOL now offers a means for fiduciaries to voluntarily correct fiduciary breaches (or potential breaches), known as the Voluntary Fiduciary Correction (VFC) Program. Details are set forth in the March 15, 2000, issue of the Federal Register (65 F.R. 14164). Through the VFC program, the fiduciary obtains a "no action" letter from the Pension and Welfare Benefits Administration (PWBA) under which PWBA agrees not to initiate a civil investigation under Title I of ERISA regarding the applicant's responsibility for any transaction described in the no action letter, or assess a civil penalty under ERISA §502(l) on the correction amount paid to the plan. Relief under the VFC program does not extend to criminal conduct. In addition, the no action letter would not bar other persons (e.g., participants) from seeking redress under ERISA. To be eligible for VFC relief, neither the plan nor the applicant may be under investigation by the PWBA, and the application must contain no evidence of potential criminal violations. VFC relief is available only for specific violations, which are listed in section 7 of the procedure: 1) delinquent participant contributions (including 401(k) contributions), 2) loan at fair market value to a party in interest, 3) below-market loans to a person who is not a party in interest, 4) below-market loans solely due to a delay in perfecting a plan's security interest, 5) purchase of an asset by the plan from a party in interest, 6) sale of an asset by the plan to a party in interest, 7) sale and leaseback of real property to an employer, 8) purchase of property from a person who is not a party in interest for a price above fair market value, 9) sale of property from a person who is not a party in interest for a price below fair market value, 10) payment of benefits without properly valuing plan assets on which payment is based, 11) duplicative, excessive, or unnecessary compensation paid by a plan, and 12) payment of dual compensation to a plan fiduciary. Guidance is provided on fair market value determinations, correction amounts, and lost earnings. An application for relief must included a completed checklist, which is provided in Appendix B of the procedure. The DOL notes that it has structured the program so that applicants have the maximum information available to identify eligible transactions and make complete and fully acceptable corrections without discussion or negotiation with the DOL. The DOL emphasizes this point because it believes that if the relief is negotiated with the DOL, the DOL is required to assess a penalty under ERISA §502(l).

IRS seeks comments on "new comparability" plans and possible new restrictions on these arrangements(added February 24, 2000). In Notice 2000-14, the IRS is seeking comments on "new comparability" plans. These plans typically provide for different levels of contributions to designated allocation groups. In many cases, the contribution level for highly compensated employees is significantly greater than for most nonhighly compensated employees. These plans satisfy IRC §401(a)(4) on the basis of benefits, meaning that the contributions are converted into equivalent benefits projected to a future retirement age, pursuant to Treas. Reg. §1.401(a)(4)-8(b) (known as "cross-testing"). For complete details on cross-testing, see Chapter 9 (Section IV) of the 1999-2000 Edition of The ERISA Outline Book. The IRS is concerned that these plans are contrary to the basic purposes of the nondiscrimination rules, even though they meet the mathematical requirements of §401(a)(4) testing. The IRS offers as a possible solution that the right to receive each rate of nonelective contributions would have to satisfy the "nondiscriminatory availability of benefits, rights, and features" test under Treas. Reg. §1.401(a)(4)-4. Currently, only rates of elective deferrals, matching contributions, and after-tax employee contributions must be available on a nondiscriminatory basis. To illustrate the impact this requirement would have, consider the following example.

• Example. A profit sharing plan provides for two allocation groups for purposes of allocating employer nonelective contributions. Group One consists of all eligible highly compensated employees, and Group Two consist of all eligible nonhighly compensated employees. Each plan year, the employer separately designates a discretionary contribution for each group, and the members of that group share pro rata in that designated contribution based on their relative compensation levels. For the current plan year, the employer designates a contribution that equals 17% of compensation for Group One and 4% of compensation for Group Two. When these contributions are converted into equivalent benefit rates (EBRs), the EBRs satisfy the "general nondiscrimination test" (also known as the "rate group test") under the §401(a)(4) regulations. If IRS were to require the availability of each rate of nonelective contributions to be nondiscriminatory, this plan design would fail §1.401(a)(4)-4 because the 17% contribution rate is available only to highly compensated employees. This would cause the plan to fail §401(a)(4) even though the EBRs satisfy the rate group test.
• The proposed "solution" would have a very negative impact on these plans. Hopefully, after hearing comments from the public, IRS will realize the viability of these programs as a means of delivering meaningful retirement benefits to employees of small companies. Although the highly compensated employees of these companies do receive greater contribution levels, they generally represent an older age group (on the average), with fewer projected years to retirement. More importantly, they represent the group who decides whether to maintain a plan. The IRS must be willing to permit some disparities in favor of highly compensated employees so that the primary goal - private pensions for employees - is attained. Furthermore, because of the contribution levels desired by the highly compensated employees are usually quite high, the contributions made for the nonhighly compensated employees, although at a lesser level, are often greater than the levels typically made by employers under so-called "vanilla" or "cookie-cutter" defined contribution plans. No doubt there have been some abusive plan designs concocted to squeeze out every possible disparity available through cross-testing. IRS' goal should be to weed out these abusive designs, but with reasonable limitations that will not send the new comparability plan design into oblivion.

IRS grants automatic waiver of 100% excise tax under §4791(b) for certain terminating defined benefit plans (added February 25, 2000). IRC §4971(b) imposes a 100% excise tax equal to the amount of the accumulated funding deficiency under a pension plan. The tax is payable after demand by the IRS. This tax is applied in addition to the normal 10% excise tax under §4971(a), so it is often referred to as a "second-tier" tax. When a defined benefit plan terminates with an accumulated funding deficiency, the second-tier tax applies unless the employer makes up the funding deficiency by the end of the plan year in which the termination occurs. IRS has the authority to waive the excise tax under certain circumstances. Rev. Rul. 2000-17 grants relief from the second-tier tax for terminated defined benefit plans that satisfy the following four conditions: 1) the plan is subject to Title IV of ERISA (i.e., PBGC coverage) and is terminated in a standard termination, 2) participants are not entitled to surplus assets, 3) the excise taxes under §4971(a) have been paid for all taxable years, including the year related to the year of plan termination, and 4) all Form 5500s have been filed (including Schedule B) for all plan years including the year of plan termination. This relief applies to plans with termination dates that occur on or after January 1, 2000.

New Form 5500 forms clarify reporting rules for defaulted participant loans (added February 9, 2000). The revised Form 5500 series released by the DOL and IRS last week clarifies how plan administrators should report participant loans in default. If: 1) the participant loan is from a participant's individual account, 2) the loan investment is segregated for the benefit of only that participant (i.e., an earmarked investment), and 3) the sole security on the loan is the participant's account balance, then the loan appears as a plan asset on Schedule H (large plan filers) or Schedule I (small plan filers) only until the plan year in which the loan is reported as a deemed distribution under IRC §72(p). In that year, the deemed distribution is included on a separate line on the Schedule H or I, and is not entered in the total for year-end assets. However, if the participant later resumes payment on the loan, a reverse distribution is reported and the loan once again appears as a reported asset of the plan. For all other participant loans (e.g., a participant loan which is held as a general trust investment), the defaulted loan (and accrued interest) continues to appear as a plan asset, and is not reported as a deemed distribution (even if the plan has reported a deemed distribution, pursuant to IRC §72(p), on Form 1099-R). The instructions to the forms caution that defaulted participant loans (plus accrued interest) continue to be recognized by the plan as an asset for purposes of applying the plan qualification rules, even if the defaulted loan has been "written off" as an asset for Form 5500 purposes. For example, the current value of the defaulted loan (which includes accrued interest) would be taken into account to determine if the plan is top heavy.

Final regulations on electronic transmission of certain distribution notices and elections, distributions of summary notices (added February 9, 2000). The IRS released final regulations yesterday under IRC §§402(f), 411(a)(11) and 3405. The regulations permit electronic transmission of the rollover notice required under §402(f), the distribution option notice required under §411(a)(11) to participants with vested interests in excess of $5,000, and the withholding election notice under §3405(e)(10)(B) for plan distributions that are not eligible for rollover. A participant may consent to a distribution via electronic media as well. The regulations also allow plan sponsors to give summaries of the §402(f) notice and/or the §411(a)(11) notice during the normal notice period (i.e., 30 to 90 days before the date of distribution), as long as a full notice has been provided at an earlier time (e.g., in the SPD) and the participant may request another copy of the full notice. The summary notice option may be provided in paper form or in electronic form. The regulations make few changes to the proposal issued on December 18, 1998. Electronic forms must be no less understandable than a paper form, and a participant must have the option to request a paper copy at no charge. The regulations are written to give employers broad flexibility in choosing the electronic medium. A procedure for electronic consent to distribution: 1) must be reasonably designed to preclude any individual other than the participant from giving the consent, 2) must provide the participant an opportunity to review and to confirm, modify, or rescind the consent before the distribution becomes effective, and 3) must provide a confirmation of the distribution (either in paper form or electronic form). The regulation clarifies the use of summaries of the §402(f) and §411(a)(11) notices. The summary must include a reference to the most recent version of the full notice previously provided. If more than one version of the full notice has been distributed, a reference to the year (or month, if more than one version was distributed in the same year) is usually sufficient. Reference to the month or year would not be necessary if only one version has been distributed. If the full notice is always available (e.g., on a plan website), that fact could be referenced in the summary. If the full notice is in another document, such as the SPD, the summary must provide a "reasonable indication of where the notice may be found in that document, such as by index reference or by section heading." The IRS also modified one of the examples to clarify that, if a participant is changing a PIN in an electronic transmission, the distribution transaction in process would not necessarily have to be discontinued, as long as the plan has adequate safeguards to ensure the participant identity when the PIN is changed. The preamble of the proposed regulations included a sample summary notice for transmitting the §402(f) notice via telephone. The IRS notes in the preamble of the final regulations that the sample was not intended to be a model notice or the exclusive form of such a notice, but was intended merely to illustrate a summary notice that, in the IRS' view, satisfies the reguirements of the regulations. The final regulations do not restate that example, nor do they provide other examples. However, use of the sample provided in the proposed regulations still should be considered satisfactory. The regulations do not address other notices, such as the notices and waivers required under the qualified joint and survivor annuity (QJSA) rules in IRC §§401(a)(11) and 417, the safe harbor 401(k) notice, and the notice of reduction of future pension accruals required by ERISA §204(h). However, Notice 2000-3 (see later summary on this What's New page) allows the safe harbor 401(k) notice to be provided electronically pending further guidance. The preamble to the regulations offers little hope that QJSA notices and waivers will be permitted, primarily because spousal consent must be witnessed by a notary or plan representative, implying that the physical presence of the spouse is necessary. The preamble also notes that future regulations under IRC §72(p) will address the use of electronic media in participant loan transactions.

TPA did not become fiduciary merely because it entered into agreement with employer to continue to provide services to the plan on the condition that the employer make the plan whole for 401(k) undeposited contributions; TPA not liable for trustee's embezzlement of funds (added February 9, 2000). In CSA 401(k) Plan v. Pension Professionals Inc., 9th Cir. November 23, 1999), the court focuses on whether a third party administration (TPA) firm could be held liable under ERISA for embezzlement of plan funds by the trustee of a plan that was a client of the TPA firm. The directly culpable fiduciary was the trustee of a 401(k) plan maintained by Computer Software Analysts, Inc. (CSA). Approximately six months into the relationship, the TPA discovered discrepancies between the amount of funds that CSA withheld from employee paychecks for 401(k) contributions and the amounts actually deposited in the employees' retirement accounts in the plan. The TPA formally notified the trustee that the failure to deposit the employees' contributions violated the law, and could be classified as both embezzlement and a breach of fiduciary duties under the ERISA. TPA also disclosed that it would have to disclose the shortage on the financial reports that it was required to prepare. CSA agreed to a repayment schedule, as outlined in a letter to the TPA. Later, CSA fell out of compliance with the repayment schedule, and provided falsified financial statements to the TPA. The TPA resigned. When it resigned, the TPA did not inform law enforcement authorities. Four years later, the trustee pleaded guilty to embezzling the missing funds. This lawsuit was brought by former employees of CSA and participants in the plan against the TPA, seeking to recover the embezzled funds. They claimed that the TPA was liable as a fiduciary for the misappropriated funds because it exercised authority and control over plan administration after its discovery of the embezzlement, and failed to take reasonable steps to warn the participants or governmental authorities. The court ruled that the TPA was not a fiduciary under the facts of this case, and thus could not be held liable as a fiduciary for the embezzlement. The court's opinion provides a good analysis of the definition of a fiduciary for ERISA purposes, and a TPA's status with respect to the plan. To be a fiduciary, a person must have discretionary authority (or exercise authority) over a plan's administration or management, or must render investment advice for a fee. See ERISA §3(21). In accordance with DOL Reg. §§2509.75-5 and 2509.75-8, a TPA is not a fiduciary if it merely performs ministerial functions, including the preparation of financial reports. The question raised by these facts is whether the TPA stepped outside the scope of rendering administrative services and in fact exercised discretionary authority or control over the plan when it discovered the apparent embezzlement and notified the plan trustee, and thereafter conditioned its continuance as a TPA upon repayment of the funds. The plaintiffs contend that the TPA's conditions for continued performance of TPA services established effective control over the plan. The court disagreed. These conditions were designed to assert control over the TPA's own engagement, and not to exercise authority or control over the plan's management or administration. Authority over the acceptance of those conditions remained with the trustee of the CSA plan. In fact, the TPA sent a letter to CSA which noted that the TPA had "no authority, nor the ability, to make the needed changes to the CSA 401(k) Plan; that is your [CSA's] responsibility." The trustee of the CSA plan were free to accept or reject the TPA's conditions. The trustee had the option of retaining another TPA. The court also expressed concern over finding fiduciary status arising from a service provider's efforts to "make things right." The court cites Beddall v. State Street Bank and Trust Co., 137 F.3d 12 (1st Cir. 1998), where a court refused to find "Good Samaritan liability" under ERISA, when a bank custodian questioned suspicious real estate valuations made by the plan's investment manager.

IRS updates guidance on automatic enrollment 401(k) plans, clarifying application of this feature to already-eligible employees (added January 30, 2000). The IRS has issued supplemental guidance on automatic enrollment 401(k) plans. An automatic enrollment plan is a 401(k) plan which provides that, in the absence of an election to the contrary, the employer automatically withholds a designated percentage (e.g., 3%) from the employee's paychecks. The automatic reduction takes effect only after the employee has had a reasonable period following receipt of the notice to make a contrary election, either to have no withholding or to withhold salary reduction contributions at a different rate. In Rev. Rul. 98-30, IRS' original guidance on automatic enrollment plans, the IRS dealt only with a situation where a newly-eligible employee was subject to the automatic enrollment provision. In Rev. Rul. 2000-8, the IRS adds a situation where an existing 401(k) plan makes the automatic enrollment provision applicable to already-eligible employees who are deferring at a rate which is less than the automatic enrollment rate.

• Example. An employer amends its 401(k) plan to provide that as of January 1, 2001, the plan will include a 3% automatic enrollment feature. The feature will apply to employees who first become eligible to the plan on or after January 1, 2001, and to already-eligible employees who, as of January 1, 2001, are either not deferring or deferring at a rate less than 3%. For the already-eligible employees who are subject to the amendment, the employer will provide notice of the feature within a reasonable period of time prior to January 1, 2001. If, before January 1, 2001, the employee fails to make a contrary election, either to have no salary reduction withholding or to have withholding at a rate other than 3%, the employer will begin withholding at a rate of 3% starting with the first paycheck issued on or after that date. At any time, the employee may file a contrary election which will be given effect as of the first pay period ending after the election is filed. Pursuant to Rev. Rul. 2000-8, contributions made under the automatic enrollment feature will be treated as 401(k) contributions.

• Critical to treatment of the contributions as 401(k) contributions is that the employee has the right to make a contrary election, including an opportunity to elect no withholding and, thus, to receive the amount in cash. It is important that, if the automatic withholding is triggered, the employee has an opportunity, at least on an annual basis, to make a contrary election. If the automatic enrollment were irrevocable, the contributions would not be treated as a elective deferrals under IRC §401(k). Instead, they would be treated as nonelective contributions made by the employer.

• In the examples given in Rev. Rul. 2000-8, the IRS refers to an annual notice provided by the employer, which reminds the employee of his deferral rate and his right to modify that rate by filing a written election. It is not clear whether the IRS intends an annual notice to be a part of the automatic enrollment plan design. Nonetheless, it would probably be good plan practice for a plan administrator, on an annual basis, to notify employees who have been enrolled automatically that they can discontinue the withholding or elect a different deferral rate. In a footnote to the ruling, the IRS also notes that where an employee is enrolled automatically, and thus has not provided written instructions regarding his election, that the fiduciary of the plan generally retains ERISA fiduciary responsibility to invest the employee's 401(k) contributions in a prudent manner, and that relief under ERISA §404(c) is probably not available until affirmative investment instructions are received from the employee. In the examples in the ruling, the plan invests the employee's automatic deferrals into a balanced fund that includes a mixture of fixed income investments and equity investments. Although this is not necessarily the only way to invest the contributions prudently, it suggests that a prudent course of action is to provide the employee a reasonable allocation of investment types with respect to his/her deferrals made under the plan's automatic enrollment feature.

Busy day for IRS news - procedure issued for obtaining GUST approval of prototype and volume submitter plans; new procedure updates consolidated procedure for IRS' correction programs for qualification failures; updated model notice for plan participants receiving eligible rollover distributions (added January 24, 2000). IRS released three important items today - 1) Revenue Procedure 2000-20 (see separate summary below), which opens up the IRS' approval programs for prototype plans and volume submitter plans to receive full review of GUST amendments, and extends the GUST remedial amendment period for adopting employers of these plans; 2) Revenue Procedure 2000-16 (see separate summary below), which updates Rev. Proc. 98-22, the consolidated procedure for obtaining relief for qualification failures under 401(a) and 403(b) plans, to incorporate the additional correction guidance provided in Rev. Proc. 99-31 (the focus topic in the Fall 1999 Issue of ERISA Views) and the folding of the 403(b) correction programs into the consolidated procedure, as outlined in Rev. Proc. 99-13; and 3) Notice 2000-11 (see separate summary below), which replaces the model tax notice originally provided in Notice 92-48 to incorporate law changes made since 1992, and allows a plan sponsor to satisfy its disclosure obligations under IRC §402(f) with respect to distributees of eligible rollover distributions. These items were released after the publication of the Winter 2000 Issue of ERISA Views (mailed on Friday, January 21, 2000). Subscribers to ERISA Views will receive full details on these items in the Spring 2000 Issue, to be published in April. In the meantime, the separate summaries provided below will give you the pertinent details of these items.

Full GUST approval for prototype and volume submitter plans; extension of remedial amendment period for adopting employer (added January 24, 2000). It's finally here! The final step in getting "full GUST approval" for prototype and volume submitter plans. GUST stands for law changes made by GATT, USERRA, SBJPA, and TRA '97, which were enacted in 1994, 1994, 1996, and 1997, respectively. Also covered by the "GUST" approval procedures is the RRA (IRS Restructuring and Reform Act of 1998), which would affect plan documents only to the extent the direct rollover provisions in the plan do not reflect the prohibition on rolling over certain hardship withdrawals from 401(k) plans (the focus topic in the Summer 1999 Issue of ERISA Views). "Full GUST approval" means review of all law changes, including those which took affect after December 31, 1998. Earlier procedures issued by IRS (see, for example, Rev. Proc. 98-14), allowed for review of pre-1999 law changes. Revenue Procedure 2000-20 sets forth the details for full GUST approval of prototype plans and volume submitter plans. The major points are listed below.

• M&P and regional prototype programs consolidated. Rev. Proc. 2000-20 consolidates the procedures for master/prototype (M&P) plans, formerly governed by Rev. Proc. 89-9, and regional prototype plans, formerly governed by Rev. Proc. 89-13 (we will occasionally refer to Rev. Proc. 89-9 and Rev. Proc. 89-13 as the "pre-GUST procedures"). The former M&P plan procedure applied to financial institutions (e.g., banks, insurance companies, mutual funds), while the former regional prototype plan procedure applied to practitioners (e.g., law firms, accounting firms, actuarial firms, third party administration firms). The terminology used for M&P plans is adopted in this consolidated program. Thus, plans that were previously designated as regional prototype plans under the pre-GUST procedures are M&P plans under the new M&P procedure. "M&P" refers to both master plans and prototype plans. The difference between the two types is how the trust is maintained for the adopting employers of the document. Under a master plan, the assets of all adopting employers' plans are invested in a single funding medium (e.g., a master trust or master custodial account). Under a prototype plan, the assets of each adopting employer's plan are invested in a separate funding medium (e.g., a separate trust or separate custodial account). With the consolidation of the procedures, a regional prototype plan is now a master plan or a prototype plan, depending on how the funding medium is handled. Under the pre-GUST procedures, sponsoring organizations of M&P plans received "opinion letters" to evidence the IRS' preapproval of each adoption agreement available with a particular basic plan document (BPD), but regional prototype plan sponsors received "notification letters" with respect to the adoption agreements available with their BPDs. Since the M&P terminology is adopted under Rev. Proc. 2000-20, former regional prototype sponsors will now receive "opinion letters" on their GUST-amended documents. These opinion letters will replace the pre-GUST notification letters issued under the sponsor's pre-GUST regional prototype plan. For the remainder of this summary, any references to "M&P plan" refers to a master or prototype plan submitted pursuant to Rev. Proc. 2000-20, regardless of whether the sponsor of the M&P plan would have been an M&P sponsor or a regional prototype sponsor under the pre-GUST procedures.

• Staggered opening for programs, starting in April for M&Ps. The GUST-approval of M&P plans opens April 7, 2000, for mass submitter plans, and May 8, 2000, for non-mass-submitter plans. GUST-amended volume submitter plans that are updated for GUST may apply for advisory letters starting March 8, 2000. All M&P applications are filed at the IRS Headquarters in Washington, D.C.. The address is Internal Revenue Service, Employee Plans Rulings and Agreements, Attention: T:EP:RA:T:ICU, P.O. Box 14073, Ben Franklin Station, Washington, D.C. 20044. However, IRS may assign some cases to the IRS field offices for actual review of the submitted plan. Volume submitters apply for advisory letters with the Key District Office in Cincinnati (Internal Revenue Service, P.O. Box 2508, Cincinnati, OH 45201, Attn: VSC Coordinator, Room 4106). Also, see section 17.02 of Rev. Proc. 2000-20, where a type of "mass submitter" is available for volume submitter sponsors to obtain a reduced-fee approval of their specimen plans. Rev. Proc. 2000-20 does not address the submission of individually-designed plans for full GUST review. However, IRS expects to issue a procedure in the near future to address the submission of individually-designed plans.

• Users of mass submitter documents will have applications filed by mass submitter. If your organization is the sponsor of an M&P document marketed by a mass submitter do NOT submit your own opinion letter applications under Rev. Proc. 2000-20. The mass submitter will be contacting you on the application procedures. Rev. Proc. 2000-20 includes procedures whereby a mass submitter will be able to submit many of the identical users of its M&P documents under abbreviated application procedures! Furthermore, if you are a minor modified adopter of a mass submitter's document, the mass submitter must submit the opinion letter applications on your behalf.

• Extension of GUST remedial amendment period for adopting employers. The GUST remedial amendment period for a plan is scheduled to end on the last day of the 2000 plan year (i.e., the plan year which begins in 2000). During the GUST remedial amendment period, a plan may be operated in accordance with the GUST law changes. By the end of the remedial amendment period, conforming amendments must be made to the plan to reflect the GUST changes, and, if applicable, a determination letter application must be filed to obtain reliance on the plan amendments. Recognizing that M&P and volume submitter sponsors will need more time to have their adopting employers adopt the GUST-amended plan and to submit for determination letters, section 19 of Rev. Proc. 2000-20 extends the GUST remedial amendment period for adopting employers. Under the extension, the adopting employer must adopt the GUST-amended M&P plan or volume submitter specimen plan by the end of the twelfth month following issuance of the opinion letter on the M&P plan or the advisory letter on the volume submitter plan and, except in the case of a standardized M&P plan that may rely on the opinion letter, submit for a determination letter (Form 5307 application) by that date. For example, if a GUST-amended M&P plan receives its opinion letter in November 2000, then the 12-month deadline would end November 30, 2001. This special extension does not affect an adopting employer whose 2000 plan year ends after the 12-month period. For example, if an M&P plan receives an opinion letter in September 2000, the 12-month period would end September 30, 2001, but an adopting employer whose 2000 plan year starts October 1, 2000, or later, would still have until the end of the 2000 plan year to amend and file for determination letter. To be entitled to the special 12-month remedial amendment period for its adopting employers, the M&P sponsor or volume submitter practitioner must submit for its GUST opinion letter or advisory letter by December 31, 2000 (or, in the case of a mass submitter M&P document, the mass submitter submits the opinion letter application on behalf of the M&P sponsor by December 31, 2000). In addition, the adopting employer: 1) must adopt an M&P plan or volume submitter plan by the end of the 2000 plan year (even if it is a pre-GUST document, or even if the M&P plan or volume submitter plan is sponsored by an organization that never sponsored an approved pre-GUST document), or 2) must execute with an M&P sponsor or volume submitter practitioner a written certification by the end of the 2000 plan year that it will adopt that M&P sponsor's M&P plan or that volume submitter practitioner's specimen plan. The certification described in 2) would normally be done by an employer who maintains an individually-designed plan but has decided to update the plan for GUST using an M&P plan or volume submitter plan. If an employer adopts (or has adopted) an M&P plan or volume submitter plan by the end of the 2000 plan year, as described in 1), but later decides to adopt the M&P plan of a different M&P sponsor or the volume submitter plan or a different practitioner, the 12-month period would run with reference to the approval of the M&P sponsor or volume submitter practitioner who sponsored the plan that was adopted by the end of the 2000 plan year, unless a certification was executed by the end of the 2000 plan year with the different M&P or volume submitter sponsor. A plan will still be treated as an M&P plan or volume submitter, for purposes of determining whether the 12-month extended amendment period applies, even if the employer has made changes to the plan that would render it "individually-designed" so long as a proper GUST-amended document is adopted by the end of the amendment period. The following examples illustrate the special 12-month amendment period.

  Example 1. An employer (ABC Company) maintains a 401(k) plan under a nonstandardized regional prototype plan sponsored by a third party administration firm (Consulting Firm). The regional prototype plan is a pre-GUST document. ABC Company's plan has a plan year ending December 31. The normal GUST remedial amendment period would end December 31, 2000. Under Rev. Proc. 2000-20, Consulting Firm's regional prototype is now an M&P plan. Consulting Firm timely submits the adoption agreements available under its GUST-amended M&P plan for opinion letters. The GUST opinion letters are issued in October 2000. ABC Company is entitled to the special 12-month period, which expires October 31, 2001 (i.e., measured from the month in which Consulting Firm's GUST opinion letter is issued). ABC Company does not have to sign a written certification by December 31, 2000, to be entitled to the October 31, 2001, deadline, because it had adopted Consulting Firm's pre-GUST regional prototype plan by December 31, 2000.

  Example 2. Assume in Example 1 that Consulting Firm used the regional prototype document of Mass Submitter X for its pre-GUST document. Consulting Firm's M&P plan amended for GUST is from Mass Submitter Y. ABC Company still is entitled to the 12-month amendment period because, by the end of its 2000 plan year, it had adopted Consulting Firm's pre-GUST document. The fact that Consulting Firm has changed document providers does not affect this.

  Example 3. Assume in Example 1, that ABC Company decides to make its GUST amendments by adopting the M&P plan of Bank Y. However, ABC Company stays on Consulting Firm's pre-GUST document until it adopts Bank Y's approved GUST document. Under the 12-month rule in Rev. Proc. 2000-20, ABC Company may restate its plan to comply with GUST by adopting Bank Y's GUST document after the end of the 2000 plan year. However, the 12-month deadline is determined with respect to the date of Consulting Firm's approval, not of the date of Bank Y's approval. Therefore, ABC Company must adopt a GUST document by October 31, 2001, regardless of whether it adopts Consulting Firm's GUST document or Bank Y's GUST document. For ABC Company to have its 12-month period measured by the date of Bank Y's approval of its GUST document, it would have to adopt Bank Y's M&P plan (either its pre-GUST document or an interim GUST document) by December 31, 2000, or it would have to execute a certification with Bank Y by December 31, 2000, stating that it will adopt Bank Y's GUST-amended M&P document.

  Example 4. Law Firm is a sponsor of a pre-GUST regional prototype plan. During 1999, the Law Firm amended its prototype plan to incorporate the GUST provisions. The Law Firm had all adopting employers of its pre-GUST document restate onto the interim GUST document. In addition, all clients establishing new plans execute the interim GUST document to do so. Law Firm timely submits the GUST document for an opinion letter. During the review by IRS, the Law Firm is required to make changes to its interim GUST document. Therefore, the interim GUST document is approved in a modified form. Approval of the final GUST document is issued in November 2000. The 12-month deadline ends November 30, 2001. The clients who had adopted the interim GUST document must execute new adoption agreements under the final GUST document by November 30, 2001, and, except in the case of a standardized plan adopter entitled to reliance on the opinion letter, file for determination letter by that date. No written certification was necessary by the end of the 2000 plan year for any employer who had adopted the interim GUST document by the end of such year.

  Example 5. Suppose in Example 4 that some of Law Firm's clients stayed on the pre-GUST plan, rather than executing the interim GUST document. Those clients are also entitled to the November 30, 2001, extended deadline because, as of the end of their 2000 plan year, the client had executed a prototype plan sponsored by the Law Firm.

  Example 6. Suppose Law Firm also has some individually-designed plan clients. If an individually-designed plan client executes a written certification with Law Firm, no later than the end of its plan's 2000 plan year, that it will adopt the GUST-amended M&P plan sponsored by Law Firm, the individually-designed plan may be timely restated on Law Firm's final GUST document by November 30, 2001, even though its 2000 plan year has ended sooner.

  Example 7. Suppose one of Law Firm's clients modified the interim GUST document to incorporate a "new comparability" formula for allocating profit sharing contributions. This amendment causes Law Firm's M&P plan to be an individually-designed plan with respect to that client. However, the plan is still treated as an M&P plan, pursuant to section 19.06 of Rev. Proc. 2000-20, for the purpose of determining the employer's eligibility for the 12-month amendment period. Therefore, the client has until November 30, 2001, to adopt a final GUST document and submit for a determination letter. If the client wants to continue with the new comparability formula, it will have to adopt a volume submitter document or an individually-designed plan document by November 30, 2001, and submit for a determination letter by that date. If the client adopts a GUST volume submitter document, that document may be sponsored by Law Firm or by any other volume submitter practitioner, so long as the document permits a new comparability allocation formula.

• Individually-designed plans not given blanket remedial amendment period extension. Rev. Proc. 2000-20 does not provide a blanket extension of the GUST remedial amendment period for individually-designed plans. Unless an individually-designed plan follows the certification procedure described above, it must be amended by the end of the 2000 plan year and, if the employer wants reliance on the GUST amendments, the plan must be submitted for a determination letter by the end of the 2000 plan year. At this time, IRS spokespersons are adamant that no further extensions of the remedial amendment period for individually-designed plans are being contemplated.

• Responsibilities of M&P sponsor. An M&P sponsor must agree to maintain a list of adopting employer on its M&P plan. The IRS has the discretion to request a copy of such list. However, the M&P sponsor is not required to submit the list to the IRS unless and until the IRS requests a copy of such list. Furthermore, under Rev. Proc. 89-13, pre-GUST regional prototype sponsors were required to provide an annual notice to every adopting employer regarding the prototype sponsor's continued sponsorship of its regional prototype plan. Rev. Proc. 2000-20 discontinues this requirement. Thus, an M&P sponsor will not have to provide any annual notice to its adopting employers, even if the sponsor would have been a regional prototype sponsor under the pre-GUST procedures. M&P sponsors must make "diligent efforts" to see that adopting employers amend their plans when necessary. In addition, if the M&P sponsor concludes that an adopting employer's M&P plan is no longer qualified, and resolution of the problem under EPCRS is not available or will not be obtained by the M&P sponsor, the M&P sponsor has an obligation to notify the employer that the plan may no longer be qualified, advise the employer that adverse tax consequences may result from the loss of qualification, and that EPCRS may be available to the employer.

• GUST documents must have way to conform to GUST operation on retroactive basis. An M&P plan will not be approved under Rev. Proc. 2000-20 unless there is a way for the adopting employer to conform the document to reflect the operation of the plan under GUST on a retroactive basis. For example, an adopting employer of an M&P 401(k) plan, must be able to state retroactive to the 1997 plan year (or, if later, the first year of the plan), which testing method was used (i.e., prior year testing method or current year testing must) to run the ADP and ACP tests. If the employer was not consistent in the testing method used from year-to-year, the M&P plan must have a way to specify such inconsistency. The M&P plan may be designed so that the retroactive amendment language pertaining to GUST operation is a "snap-on" section of the adoption agreement. With a "snap-on" approach, an adopting employer who is not executing the M&P plan for the purpose of restating its plan for GUST (e.g., an employer who adopts the M&P plan in 2003, after having amended for GUST in an earlier plan year) would be furnished an adoption agreement that does not include the snap-on section.

• ADP and ACP testing method must be consistent after adoption of GUST document. The adopting employer of an M&P plan approved under Rev. Proc. 2000-20 must specify the same testing method for ADP and ACP testing. In other words, the employer may not use the prior year testing method for one test and the current year testing method for the other. However, this requirement applies only to plan years that start after the adoption of the GUST-approved M&P plan. For prior years, a different method could be used for each test, but the retroactive amendment reflecting the GUST operation (see prior paragraph) would have to reflect that the employer used a different method for the ADP test than it used for the ACP test.

• No "new comparability" or other "non-uniform" plan designs allowed in nonstandardized plans. Rev. Proc. 2000-20 makes clear that nonstandardized M&P plans approved under this procedure will not be able to include nonuniform allocation formulas (e.g., different allocation rates for different groups of employees). An exception is made for Davis-Bacon plans and for "uniform points plans," as described in §1.401(a)(4)-2(b)(3). Thus, nonstandardized plans may not be designed as "new comparability" plans, where the employer makes separate discretionary contributions for designated allocation groups, with the intention of relying on the general nondiscrimination test under §1.401(a)(4)-3. However, a volume submitter plan may incorporate these new comparability formulas.

• More flexible reliance procedures for standardized plans. Under the pre-GUST procedures, an employer could not rely on the opinion letter or notification letter issued on a standardized defined contribution plan if the employer maintained (or ever maintained) another defined contribution plan or a defined benefit plan, unless the other plan was a paired plan. An employer who adopts a standardized M&P plan approved under Rev. Proc. 2000-20 may rely on the opinion letter, even though the employer maintained a prior defined contribution plan or prior defined benefit plan that was not a paired plan, so long as: 1) the non-paired plan was terminated before the effective date of the standardized plan, 2) in the case of a prior defined contribution plan, no annual additions were credited to that prior plan during a limitation year of the standardized plan, and 3) in the case of a prior defined benefit plan, the standardized defined contribution plan must have become effective after the repeal of IRC §415(e). The restatement of an existing plan by a standardized plan is not treated as the maintenance of a prior non-paired plan, so long as the plan being restated is the same type (i.e., a profit sharing plan is being restated into a standardized profit sharing plan, or a money purchase plan is being restated into a standardized money purchase plan).

EPCRS procedures consolidated (added January 24, 2000). Revenue Procedure 2000-16 replaces Rev. Proc. 98-22 (which consolidated the APRSC, VCR and CAP resolution programs into a single procedure known as the Employee Plans Compliance Resolution System, or EPCRS), Rev. Proc. 99-13 (which folded the TVC program for section 403(b) plans into Rev. Proc. 98-22, and enabled 403(b) plans to rely on APRSC for self-correcting certain operational violations), and Rev. Proc. 99-31, which provided supplemental correction guidance for defects being corrected under Rev. Proc. 98-22. No real substantive changes are made to the procedures. The primary purpose of the procedure is to make it easier for IRS to update the correction procedures. It anticipates that the IRS will issue an annual update of this procedure, and to expand correction guidance in some of those future updates. The supplemental correction guidance that was contained in Rev. Proc. 99-31 (see the Fall 1999 Issue of ERISA Views for a detailed discussion of Rev. Proc. 99-31) is now contained primarily in Appendix B of Rev. Proc. 2000-16. (Appendix B under Rev. Proc. 98-22, which provided a checklist to be included with a VCR, TVC, or Walk-in CAP submission, is now Appendix C of Rev. Proc. 2000-16.) Section 6.04(3) of Rev. Proc. 2000-16 allows an employer to request a waiver of excise taxes under IRC §4974 if a failure to comply with the minimum distribution requirements under a qualified plan or section 403(b) plan is corrected under the VCR, TVC or Walk-in CAP programs. The IRS will waive the excise tax in "appropriate cases," but does not offer more specifics on what cases would be appropriate. But for the waiver of §4974 excise taxes, no other applicable excise taxes are waived merely because qualification relief is obtained through Rev. Proc. 2000-16. The procedure is effective May 1, 2000, but employers may request retroactive application of the procedure to pending cases under Rev. Proc. 98-22.

Revised model rollover notice (added January 24, 2000). IRC §402(f) requires a plan administrator to supply the distributee of an eligible rollover distribution an explanation of the direct rollover option and the income tax withholding requirements for failing to elect a direct rollover (i.e., 20% mandatory federal income tax withholding). In Notice 92-48, the IRS issued a model notice which could be used by a plan administrator to satisfy its §402(f) disclosure obligations. Since the publication of Notice 92-48, there have been a number of statutory or regulatory changes that affect the information contained in Notice 92-48. Notice 2000-11 provides an update model notice. A plan administrator is not required to use the model notice. It may modify the notice in any fashion is wishes, or it may design its own notice, so long as the notice provided to distributees satisfies the disclosure obligations under §402(f). Notice 2000-11 incorporates the following information that reflects new law or modified law since the publication of Notice 92-48.

• 1) Notice 2000-11 notes that Roth IRAs, SIMPLE-IRAs, and Education IRAs may not receive a rollover from a qualified plan or section 403(b) plan.
• 2) 5-year income averaging was eliminated for lump sum distributions paid after December 31, 1999. Notice 2000-11 includes a paragraph on the 10-year averaging election which is available only to participants born before 1936 (and the death beneficiaries of such participants), but provides no explanation of the pre-2000 5-year averaging election. The explanation of 10-year averaging also notes that all or part of the lump sum distribution might be eligible for capital gains treatment, which was also protected for participants born before 1936.
• 3) Hardship withdrawals from 401(k) plans may no longer be eligible for rollover (see the Summer 1999 Issue of ERISA Views for more details on the application of the rollover rules to hardship withdrawals). Notice 2000-11 simply refers the distributee to the plan administrator for more details on whether any portion of his/her hardship withdrawal is ineligible for rollover.
• 4) A paragraph is included in Notice 2000-11 on the treatment of loan offsets. If, as part of the distribution, a participant loan is being offset, the offset amount is eligible for rollover. Notice 2000-11 notes that if the distributee does not rollover an amount equal to the amount of the loan offset within 60 days of the offset, the amount not rolled over is taxable income. The 20% withholding rules are also explained in the context of a loan offset. If the loan offset represents the only taxable amount, there is no mandatory withholding. However, if part of the non-offset amount is not directly rolled over, the 20% withholding liability is the lesser of 20% of the entire value not rolled over (including the loan offset amount) or 100% of the non-offset amount which is not directly rolled over. Details on the application of the withholding rules to loan offsets can be found in the 1999-2000 Edition of The ERISA Outline Book, on page 7.142.

Other news. The capsules which appear after this paragraph are discussed (often in more detail) in the Winter 2000 Issue of ERISA Views (published January 21, 2000) or in earlier issues of ERISA Views.

Annual update of revenue procedures (added January 17, 2000). The IRS has released annual updates for procedures to obtain private letter rulings on employee plans matters (Rev. Proc. 2000-4, replacing Rev. Proc. 99-4), technical advice memoranda on employee plans matters (Rev. Proc. 2000-5, replacing Rev. Proc. 99-5), and determination letters on qualified plans (Rev. Proc. 2000-6, replacing Rev. Proc. 99-6). The annual update on user fees can be found in Rev. Proc. 2000-8 (replaces Rev. Proc. 99-8). The changes to all of the these procedures are minor, reflecting clarifications, and the reorganization of the IRS (i.e., the creation of the Tax Exempt and Government Entities Division - TE/GE). Rev. Proc. 2000-6 clarifies that employers may continue to rely on a favorable determination letter issued to a multiple employer plan after other employers join the plan. Rev. Proc. 2000-5 adds to the list of issues for which the field office is required to request technical advice to include the conversion of a traditional defined benefit plan into a cash balance defined benefit plan. This year's user fee update (Rev. Proc. 2000-8) includes no substantive changes affecting the user fees for determination letters. However, fees for most private letter rulings and opinion letters have been increased. For example, the general fee for a private letter ruling request increases from $2,100 to $2,275, and the user fee for an opinion letter request by an organization which is an identical adopter of a mass submitter's M&P plan is increased from $100 to $110 per adoption agreement. Sections 6.01(11) and 6.08(6), concerning reduced fees for private letter rulings for applicants whose income or gross receipts do not exceed a prescribed level, are modified to increase the qualifying level of assets from $150,000 to $200,000.

Update of ruling regarding QTIP election on IRAs (added January 17, 2000). Under Revenue Ruling 2000-2, an executor may elect QTIP treatment for an IRA (and the testamentary trust which receives payments from the IRA) if: 1) the trustee of the testamentary trust is the named beneficiary of the IRA, 2) the surviving spouse can compel the trustee to withdraw from the IRA an amount equal to all the income earned on the IRA assets at least annually and to distribute that amount to the surviving spouse, and 3) no person has a power to appoint any part of the trust property (including the IRA assets) to any person other than the spouse. A QTIP election, which is made pursuant to IRC §2056(b)(7), treats a terminable interest as passing to the surviving spouse, allowing a marital deduction to the decedent's estate. Rev. Rul. 89-89, 1989-2 C.B. 231 is obsoleted.

IRS releases supplemental guidance on safe harbor 401k plans (added January 6, 2000; amended January 7 and 8, 2000). Notice 2000-3 clarifies some issues for safe harbor 401k plans and provides plan sponsors a great deal more flexibility in offering these types of plans. Here are some highlights. Details will appear in the Winter 2000 Issue of ERISA Views, to be published in late January.

• Adding safe harbor to an existing non-401k plan. One of the issues that hampered formation of safe harbor 401k plans involved the addition of a 401k arrangement to an existing non-401k plan (e.g., existing profit sharing plan). IRS had been interpreting Notice 98-52 as requiring the 401k arrangement to be added only as of the first day of a plan year. Notice 2000-3 provides relief. Under the notice, the addition of a 401k arrangement is treated as a new plan for purposes of the safe harbor 401k rules. Thus, the employer may add the arrangement after the first day of the plan year, and the notice requirements can be satisfied as of the first day that the 401k arrangement is in effect. As is the case with the establishment of a new plan, a safe harbor 401k arrangement may not be added to an existing non-401k plan unless the 401k arrangement will be in effect for at least 3 months. For example, suppose an employer maintains a calendar-year profit sharing plan. For the plan year that began January 1, 2000, the employer may add a safe harbor 401k arrangement as late as October 1, 2000, so long as the safe harbor requirements are met from the effective date of the 401k arrangement to the end of that first year. The safe harbor notice would have to be given to employees no later than the effective date of the 401k arrangement.
• Committing to the safe harbor contribution. Under Notice 98-52, an employer, if it already maintains a plan, has to commit to the safe harbor 401k arrangement before the beginning of the plan year. Notice 2000-3 is more flexible. First, if the employer is choosing to provide the 3% nonelective contribution as the safe harbor contribution, a decision can be made as late as 30 days before the last day of the plan year as to whether to provide the contribution. The notice given to employees before the beginning of the plan year would simply indicate that the employer might decide to make the nonelective contribution. If the employer later decides to do so, a supplemental notice would be given (no later than 30 days before the end of the plan year). Second, if the employer wants to do the safe harbor matching contribution instead of the nonelective contribution, the employees would have to be notified of that decision during the normal notice period (i.e., 30-90 days before the first day of the plan year), but the employer later could decide to discontinue the match during the plan year (with prior notice to employees) and opt to run ADP/ACP testing that year. The discontinuance of the match could take effect sooner than 30 days after notice of such discontinuance is given to the employees.
• Calculating the safe harbor match. Also affecting the safe harbor match is the ability to calculate the match over a shorter period than the entire plan year. Notice 98-52 required the safe harbor match formula to be applied to the entire year's compensation, requiring a "true up" at the end of the year if an employee's elective deferral rate was not constant during the entire year. Notice 2000-3 will permit employers to calculate the safe harbor match under what IRS calls the "payroll period method." Under the payroll period method, the match is separately determined for each payroll period, or on a monthly basis (i.e., all payroll periods ending in each month), or a quarterly basis instead (i.e., all payroll periods ending in each plan year quarter). If this method is adopted, the employer would be required to actually deposit the match for each plan year quarter as of the last day of the next quarter. For example, suppose the employer determines the safe harbor match separately for each payroll period. For payrolls periods ending in the third quarter of 2000, the matching contributions would have to be deposited by December 31, 2000.
• More time to do 2000 notice. For plans that are using the 401k safe harbor for the first time in 2000, the notice date is extended to May 1, 2000 (if the normal notice period would end sooner). This would affect plan years that begin on or after January 1, 2000, and before June 1, 2000.
• Other issues. Notice 2000-3 also: 1) permits safe harbor 401k plans to require salary reduction elections to be in whole dollar amounts or in whole percentages of compensation, 2) clarifies that safe harbor 401k plans may suspend an employee's right to make employee after-tax contributions (up to 12 months) if he withdraws his employee contributions, 3) allows the safe harbor notice to be given electronically, 4) permits much of the information required in the safe harbor notice to be cross-referenced to the SPD, and 5) clarifies that if the employer elects to disaggregate otherwise excludable employees in order to limit the safe harbor provisions to employees who satisfy the statutory age and service requirements (i.e., one year of service and age 21), ADP/ACP testing is required for the otherwise excludable employees if there are any HCEs in the otherwise excludable employee group.

IRS revenue ruling cautions against crediting benefit accrual service in discriminatory manner (added December 13, 1999). In Revenue Ruling 99-51, the IRS addresses a situation involving the crediting for service for benefit accrual purposes under a defined benefit plan. Originally, the employer maintained a single defined benefit plan (Plan X) for its highly compensated employees (HCEs) and nonhighly compensated employees (NHCs). In 1997, the employer spunoff two plans from the original plan: Plan X-H covered just HCEs and Plan X-N covered just NHCs. Plan X-H was then frozen, so that the HCEs were no longer accruing benefits. Now the employer is amending Plan X-N to add the HCEs into that plan and have them start accruing benefits again. To determine the benefits of the HCEs, Plan X-N credits all years of service, including service earned before the HCEs' commencement of participation in Plan X-N. The IRS ruled that Plan X-N is crediting service in a discriminatory fashion, in violation of Treas. Reg. §1.401(a)(4)-11(d)(2). That regulation states that the manner in which employees' service is credited for all purposes under the plan must not discriminate in favor of HCEs. Treas. Reg. §1.401(a)(4)-11(d)(3) provides that periods prior to an employee's commencement of participation in the plan (pre-participation service) may not be taken into account in determining whether §401(a)(4) is satisfied, unless certain conditions are satisfied. To determine whether the appropriate conditions exist for the crediting of pre-participation service, §1.401(a)(4)-11(d)(3) examines whether the granting of pre-participation service applies to all similarly-situated employees, whether there is a legitimate business reason for the service credits, and whether there would be significant discrimination in favor of HCEs. With respect to significant discrimination in favor of HCEs, the relevant factors include the reciprocity of the service crediting feature. The effect of crediting the HCEs' pre-participation service in Plan X-N is to duplicate benefits with respect to the same years of service. An HCE who had service with the company prior to spinoff of Plan X-H and Plan X-N from Plan X has accrued benefits with respect to that service in both Plan X-H and Plan X-N, and Plan X-N does not offset for the benefits accrued in Plan X-H. The NHCs covered by Plan X-N get no such benefit with respect to their service credits earned before the spinoff of Plan X-N from Plan X. The ruling underscores the importance of testing all discrimination issues raised in the §401(a)(4) regulations. The employer might have been able to demonstrate that the accrual rates of the HCEs in Plan X-N would satisfy the nondiscrimination testing requirements of §1.401(a)(4)-3. Nonetheless, the manner of crediting service is a separate nondiscrimination testing issue, by virtue of the rules set forth in §1.401(a)(4)-11. The duplicate use of service to accrue benefits in two different plans, where such duplicate use applies only the HCEs and not to NHCs, is a violation of §1.401(a)(4)-11, even if the amount of benefits being accrued satisfies §1.401(a)(4)-3.

5-year income averaging expires December 31, 1999, but not grandfathered 10-year averaging (added December 8, 1999). The option to elect 5-year income averaging on a lump sum distribution expires on December 31, 1999. To qualify for the election: 1) the plan participant must be at least age 59-1/2; 2) the lump sum distribution must be paid by December 31, 1999; 3) the lump sum distribution must satisfy the requirements of IRC §402(d) (as in effect for tax years beginning on or before December 31, 1999); and 4) the distribution must be from a qualified plan (i.e., a plan which satisfies the requirements of IRC §401(a)). Of course, the participant will have to be eligible to take a distribution from the qualified plan in order to receive the lump sum distribution. Income averaging treatment is not available for lump sum distributions from IRAs, section 403(b) plans, or section 457 plans. The repeal of the 5-year income averaging provision does not repeal the grandfathered 10-year averaging provision that was protected by the Tax Reform Act of 1986. A participant is not eligible for 10-year income averaging unless he was born before 1936. The distribution must satisfy the same definition of lump sum distribution that is used for the 5-year averaging election. The 1986 income tax tables are used to calculate the income tax under the 10-year averaging election. A participant who was born before 1936, and who is paid a lump sum distribution before January 1, 2000, may choose between the 5-year income averaging calculation (which is based on the tax rates in effect in the year of distribution) or the 10-year income averaging calculation. If the lump sum distribution is paid after December 31, 1999, only the 10-year income averaging election is available. A death beneficiary is eligible for the same income averaging election as the participant, provided that an income averaging election had not been made by the participant. The deceased participant's age is used to determine the beneficiary's eligibility for the income averaging election. In other words, if a death beneficiary is paid a lump sum distribution by December 31, 1999, and the deceased participant was at least age 59-1/2 when he/she died, then the 5-year income averaging is available. In addition, if the deceased participant was born before 1936, then the beneficiary may choose between 5-year income averaging and 10-year income averaging. For lump sums paid to a death beneficiary after December 31, 1999, only 10-year income averaging is available for lump sum received after December 31, 1999, and only if the decedent was born before 1936.

Are you prepared for new pension rules taking effect on January 1, 2000? (added December 3, 1999) There are three changes that take effect January 1, 2000, which might significantly affect plan administrators and for which, in some cases, plan sponsors might wish to adopt plan amendments.

• Hardship withdrawals from 401(k) plans. Effective January 1, 2000, a hardship withdrawal of 401(k) contributions is not eligible for rollover. That means the 20% mandatory withholding rate for federal income taxes, which normally applies to single-sum distributions from qualified plans, is not applicable. Instead, the normal withholding rate is 10% and the employee is permitted to waive withholding (see IRS Form W-4P). A few things to remember about this new rule: (1) the rollover prohibition applies only to the 401(k) contributions being withdrawn under the plan's hardship provision - other sources of employer contributions (e.g., employer match, employer nonelective contributions) that are withdrawn for hardship reasons continue to be eligible for rollover; (2) this rule technically took effect January 1, 1999, but IRS Notice 99-5 postponed mandatory compliance until January 1, 2000; (3) extensions of the GUST remedial amendment period do not affect the compliance date for this rule - January 1, 2000 is the mandatory compliance date even though the GUST amendment deadline is later; (4) the January 1, 2000, effective date applies regardless of the plan's plan year; (5) if the employee receiving the hardship withdrawal has separated from service or has attained age 59-1/2, a hardship withdrawal of 401(k) contributions is still eligible for rollover - thus, the rollover prohibition only applies to employees who take in-service hardship withdrawals of 401(k) contributions when they are under age 59-1/2; and (6) similar rules apply to 403(b) plans. For more details, see the Summer 1999 Issue of ERISA Views!
• Repeal of IRC §415(e). Effective on the first day of the first limitation year (generally defined by the plan as the plan year) which begins on or after January 1, 2000, the limit under §415(e) is repealed. The §415(e) limit capped the overall amount an employee could accumulate in a combination of defined benefit plans and defined contribution plans maintained by the same employer (or maintained by more than one employer in the same controlled group or affiliated service group, as defined in IRC §414(b), (c) or (m)). The repeal is automatic, but depending on how your plan is written, the repeal may not affect the accrual of benefits until after the plan is amended. If the plan simply incorporates the §415(e) limit by reference, the repeal will automatically go away under the plan as of the first day of the 2000 limitation year. This could result in a "pop-up" of accrued benefits under a defined benefit plan, which a plan sponsor may not be prepared for from a funding standpoint. To avoid the "pop-up" an amendment would have to be adopted before the first day of the 2000 limitation year. If the plan does not incorporate §415(e) by reference, the plan sponsor can decide operationally whether to allow benefits to "pop-up" before the plan is amended to reflect the repeal of §415(e). If the repeal of §415(e) is delayed under the plan (either by automatic "pop-up" or by an operational election not to "pop-up") there are some qualification issues raised by the IRS. For more details, see IRS Notice 99-44, and the Fall 1999 Issue of ERISA Views.
• GATT amendments to interest rate assumptions used by defined benefit plans. The GATT legislation enacted in 1994 included several pension provisions, mostly affecting defined benefit plans. Two of those provisions affected the interest rate and mortality assumptions used by defined benefit plans to calculate lump sum distributions under IRC §417(e) and to calculate maximum optional forms of benefit under IRC §415(b). A defined benefit plan that was in existence before December 8, 1994, has the option to decide the effective date of these GATT rules, provided the effective date is no later than the first day of the 2000 plan year (the first plan year which starts on or after January 1, 2000). If the plan is waiting to implement the GATT rules for §417(e) and/or §415 as of the 2000 plan year, the implementation may be done operationally, with conforming amendments adopted by the end of the GUST remedial amendment period. However, the employer may want to actually adopt an interim amendment with respect to the §417(e) change. If the §417(e) change is implemented operationally as of the first day of the 2000 plan year, but the conforming amendment is not adopted until later, then lump sum distributions made from the effective date to the date of the amendment will have to reflect the greater of the lump sum calculated under the plan's pre-GATT rules and the lump sum calculated under the plan's GATT rules. For more details, see IRS Rev. Proc. 99-23, and the Current Developments section of the Spring 1999 Issue of ERISA Views.

DOL proposes rules that will subject certain small plans to an annual audit requirement (added December 1, 1999). Presently, DOL Regulation §2520.104-46 blanketly exempts all small plans from the annual audit requirement (i.e., engaging an independent qualified public accountant to examine the financial statements of the plan and to issue a report to be attached to the Form 5500). A "small plan" is a plan that has fewer than 100 participants at the beginning of the plan year (or has 100-120 participants, but is electing to be treated as a small plan, pursuant to DOL Regulation §2520.103-1(d)). Proposed regulations issued today (see 64 F.R. 67436) will require small employee pension benefit plans (i.e., small deferred compensation plans, such as profit sharing plans, 401(k) plans, money purchase plans, defined benefit plans) to meet certain conditions in order to be exempt from the audit requirement. Those plans that cannot meet these conditions will have to engage an accountant to audit the plan and attach the accountant's report to the plan's Form 5500. The regulations would be effective 60 days after publication of a final rule, and would pertain to plan years which begin after the effective date. Small welfare benefit plans will not be subject to these new rules, and will continue to be exempt from the audit requirement, without condition.

• To be exempt from the audit requirement, the plan would have to: (1) have at least 95% of its assets invested in "qualifying" plan assets, or (2) if the 95% requirement is not satisfied, obtain a bond for any person who handles assets that do not constitute qualifying plan assets in an amount that is not less than the value of such assets. Qualifying plan assets are any of the following: qualifying employer securities, participant loans which meet the prohibited transaction exemption requirements, assets held by a bank or similar financial institution, as defined in DOL Regulation §2550.408b-4(c), assets held by an insurance company, assets held by a registered broker-dealer, or assets held by any other organization that is authorized to act as a trustee of IRAs.
• In addition to meeting one of the two requirements in the prior paragraph, the summary annual report would have to include: (1) information about the name of each institution holding qualifying plan assets and the amount of such assets held by such institution as of the end of the plan year, (2) if applicable, information about the surety company issuing a bond described in the prior paragraph, (3) a notice that the participants and beneficiaries may request a copy without charge of any bond described in (2) and statements received from each institution holding qualifying plan assets which describe the assets held by the institution as of the end of the plan year, and (4) a notice that the participants and beneficiaries should contact the DOL's Pension and Welfare Benefits Administration if they are unable to examine or obtain copies of these items. If a request described in (3) is received, the plan administrator must provide the requested documents, or the exemption from the audit requirement would not be applicable.
• The DOL feels this proposal will increase the security of assets in small plans, by conditioning the waiver of the audit requirement on enhanced disclosure of information to participants and beneficiaries, and where the plan invests more than 5% of its assets in nonqualifying plan assets, by improving the bonding requirements. Written comments on the proposal must be received by January 30, 2000.

Prior dividend distributions do not preclude lump sum treatment under §402(d) (added November 30, 1999). In PLR 199947041, the IRS takes the position that dividend distributions under an ESOP, made pursuant to IRC §404(k), are not taken into account as part of the participant's "balance to the credit" in the plan for lump sum distribution treatment under §402(d). In the ruling, an employee received an in-service distribution of his account balance pursuant to a plan provision that allows such distributions after an employee has attained age 68-1/2 and has earned at least 10 years of service. This employee had received dividend distributions in prior years, including years following his attainment of age 59-1/2. To qualify for lump sum treatment (i.e., 5-year income averaging or, in the case of an individual born before 1936, 10-year income averaging), the "balance to the credit" of the employee must be distributed within one taxable year following a proper distribution event listed in §402(d)(4)(A). There is only one event under §402(d)(4)(A) that could apply to the employee in this case - attainment of age 59-1/2 - since the employee was still in service. When an employee relies on the age 59-1/2 distribution event for lump sum purposes, the "balance to the credit" distribution must occur in a taxable year that ends after the employee reaches age 59-1/2 and must be the only distributions since age 59-1/2 was attained. Thus, the prior dividend distributions which had been made since the employee reached age 59-1/2 raised an important issue, because if they counted as distributions for §402(d) purposes, the payment of the employee's account balance when he reached age 68-1/2 would not have qualified as a lump sum distribution under §402(d). The IRS ruled that the dividend distributions are not distributions for this purpose, so the account balance distribution qualified for income-averaging treatment.

2000 covered compensation table released (added November 30, 1999). The IRS has released the 2000 covered compensation table - see Revenue Ruling 99-47. The new table reflects the increase in the taxable wage base for 2000 to $76,200. The covered compensation table is used to determine "integration levels" under defined benefit plans that use permitted disparity in their benefit formulas, or which impute permitted disparity for general nondiscrimination testing purposes under IRC §401(a)(4). (Note that some defined benefit plans with permitted disparity benefit formulas only adjust the covered compensation at periodic intervals - e.g., every 5 years - so the 2000 covered compensation table may not affect the plan's benefit computations.) The 2000 covered compensation table only affects individuals born in 1935 or later, because individuals born before 1935 reached social security retirement age before 2000. An individuals covered compensation is the average of the taxable wage bases in effect for the 35-year period ending with the year in which the individual reaches the social security retirement age, assuming that the taxable wage base for future years is the same as for the current calendar year. Thus, for purposes of the 2000 covered compensation table, the 2000 taxable wage base of $76,200 is assumed to be in effect for all future calendar years. For individuals born in 1967 or later, who in 2000 will have at least 35 years to social security retirement age, the covered compensation equals the 2000 taxable wage base ($76,200). For other individuals born before 1967, the covered compensation is less than $76,200.

DOL proposes extension of interest-free loans to plans that experience Y2K problems (added November 30, 1999). In PTE 80-26, the Department of Labor (DOL) permits a party-in-interest, including the plan sponsor, to lend money to a plan to cover operating expenses or expenses which are incidental to the plan's operation. The loan must be interest free. PTE 80-26 does not limit the term of an interest-free loan that is made to cover operating expenses, which include plan distributions and premiums for insurance purchased to fund benefits under the plan. However, if the loan is for expenses which are incidental to the plan's operation, the term of the interest-free loan may not exceed 3 days. On November 29, 1999, the DOL proposed (see 64 F.R. 66666) to amend PTE 80-26 to allow interest-free loans to extend beyond 3 days for incidental expenses that arise from a plan's inability to liquidate or otherwise access its assets or data as a result of the Y2K problem. To qualify for prohibited transaction relief, the loan would have to be repaid no later than December 31, 2000. Note that the December 31, 2000, repayment deadline is required only if the loan is for purposes that are incidental to the plan's operation. If the Y2K problem causes a plan to be unable to satisfy a plan distribution obligation, or other operating expense, the interest-free loan could extend beyond 3 days, and would not even have to be repayable by December 31, 2000, without regard to this proposed amendment of PTE 80-26. The DOL, in the preamble to the proposed amendment, notes the following examples of transactions which may require loans or extensions of credit that exceed 3 days: 1) transfer of all or part of a participant's account balance from one investment option to another, 2)a participant loan, 3) temporary overdraft protection, 4) failure of a plan's internal computer systems, and 5) the crediting of dividends or interest by a bank trustee prior to receipt of such dividends or interest.

Tax Court rejects IRS requirement that plan expenses must be recurring to be deductible under IRC §162 (added November 16, 1999). In Rev. Rul. 86-142, the IRS provides that an employer take a deduction under IRC §162 for plan expenses that the employer pays directly, provided that the expenses are ordinary and necessary with respect to the plan's operation or administration, and are recurring. In Sklar, Greenstein & Scheer, P.C. v. Commissioner, 113 T.C. No. 9 (Tax. Ct. August 13, 1999), an employer paid expenses incurred by its money purchase plan to litigate a suit against an investment manager. The employer claimed the deduction under IRC §162. The IRS argued that it was not deductible under IRC §162 because the litigation expenses are not recurring in nature, relying on Rev. Rul. 86-142. The Tax Court rejected the "recurring in nature" requirement under Rev. Rul. 86-142. The deductibility of the payment is governed by Treas. Reg. §1.404(a)-3(d), which provides: "Any expenses incurred by the employer in connection with the plan, such as trustee's and actuary's fees, which are not provided for by contributions under the plan are deductible by the employer under section 162 . . . to the extent that they are ordinary and necessary." There is no "recurring" requirement under section 162, and IRS' attempt to overlay such a requirement through Rev. Rul. 86-142 is not appropriate. Note that the Tax Court is not rejecting Rev. Rul. 86-142 in its entirety. It merely is rejecting the notion that plan expenses paid separately by the employer must be recurring in nature in order to be deductible under IRC §162. In footnote 11 of the opinion, the court notes that its ruling would not affect the issue raised in Rev. Rul. 86-142 with respect to broker's commissions. Rev. Rul. 86-142 provides that an employer's separate payment of broker's commissions relating to investment transactions made by the plan is not deductible under IRC §162 because the payment is "instrinsic to the value of the trust's assets." Thus, the IRS treats separate payment of broker's commissions as indirect contributions to the plan and deductible under the limits prescribed by IRC §404. The Tax Court would apparently agree with this conclusion.

IRS says $85,000 test for HCE not applicable until 2001 plan year (added October 25, 1999). On October 21 we reported that the IRS has announced an increase in the HCE compensation test from $80,000 to $85,000 (see report below). At the ASPA Conference in Washington D.C. today, Jim Holland the IRS clarified how this increase is to be applied. The increase is used to calculate compensation for lookback years which begin in 2000. Under the HCE compensation test, an employee is a HCE for a plan year if that employee's compensation for the lookback year exceeds the prescribed dollar limit. The lookback year is the 12-month period which precedes the current plan year. For example, for a plan year beginning January 1, 2000, compensation is measured from January 1 through December 31, 1999. Since the lookback year for the 2000 plan year begins in 1999, it is the 1999 dollar amount which applies. For 1999, the compensation dollar amount for 1999 was still at $80,000. Therefore, the first year the $85,000 will actually be used to determine HCEs is the first plan year which begins in 2001. The lookback year for that plan year will start in 2000, thus requiring use of the $85,000 limit.

• Example 1. A plan has a plan year which ends December 31. For the plan year starting January 1, 2001, the plan will look at compensation for 2000 to see who satisfies the HCE compensation test. An employee's 2000 compensation will have to exceed $85,000 to satisfy that test.
• Example 2. A plan has a plan year which ends June 30. The $80,000 test is still used to determine HCEs for the plan year which starts July 1, 2000, and ends June 30, 2001, because the lookback year for that plan year (i.e. July 1, 1999, through June 30, 2000) begins in 1999. The $85,000 test will first apply to the plan year ending June 30, 2002, when the lookback year for such plan year will begin in 2000.

COLAs on dollar limits (added October 21, 1999). IRS has announced the new dollar limits for 2000.

• Elective deferral limit (section 402(g)) - $10,500
• Highly compensated employee compensation requirement (section 414(q)) - $85,000
• Section 415 limits - $30,000 for defined contribution (no change); $135,000 for defined benefit
• Compensation dollar limit (section 401(a)(17)) - $170,000
• SIMPLE plan elective contribution limit - $6,000 (no change)
• Section 457 plan deferral limit - $8,000 (no change)
• Taxable wage base - $76,200

Taxpayers have until December 31, 1999, to recharacterize 1998 Roth contributions (added October 15, 1999). Recognizing that some taxpayers may not be fully aware of the new Roth IRA rules, the IRS is giving taxpayers until December 31, 1999, to recharacterize 1998 IRA contributions, pursuant to section 408A(d)(6) of the tax code. That means the taxpayer may elect to treat a 1998 Roth IRA contribution as a traditional IRA contribution (or a 1998 traditional IRA contribution as a Roth IRA contribution), or to recharacterize a 1998 Roth conversion back to a traditional IRA during this extended period, so long as the 1998 tax return was filed timely. The taxpayer will have to file an amended return for 1998 (by April 15, 2002) if the effect of the recharaterization is to change the tax information on the 1998 return that was previously filed.

Use of S corporation dividends on allocated ESOP shares to repay exempt loan will cause loan to fail exemption requirements (added September 27, 1999). In PLR 199938052, an S Corporation maintained an ESOP. For the year in question, the corporation used dividends paid on both allocated and unallocated shares in the ESOP to repay the outstanding exempt loan. The IRS ruled that the use of dividends on allocated shares to repay the loan was a violation of Treas. Reg. §54.4975-7(b)(5) and caused the exempt loan to fail to satisfy the prohibited transaction exemption requirements of IRC §4975(d)(3). That regulation only permits the exempt loan to be repaid with the collateral (i.e., unallocated shares held in the suspense account), employer contributions made to repay the loan, and earnings on the collateral (i.e., earnings on unallocated shares. It does not provide for repayment of the loan with earnings on allocated shares. It should be noted that IRC §404(k) provides an exception to this rule, whereby dividends paid on allocated shares may be used to repay the exempt loan, so long as the participant receives an allocation of employer securities from the suspense account which have a fair market value at least equal to the amount of the dividend. See IRC §404(k)(2)(B). Unfortunately, §404(k)(2)(B) was not available here because the employer is an S corporation. IRC §404(k)(1) limits application of §404(k) to C corporations.

Community property interest in an IRA is recognizable, but transfer of such interest to individual's own IRA is taxable to the IRA owner and not eligible for special treatment under IRC §408(d)(6) (added September 27, 1999). In PLR 199937055, A and B are married and reside in a community property state. A maintains two IRAs in his name. As part of an estate plan, A and B have agreed to classify A's two IRAs as marital property, so that under applicable community property law, A and B will be treated as having an undivided one-half interest in each IRA. The IRAs will then be severed into two separate equal shares and B's shares will be transferred to her own IRA (assuming a favorable tax ruling is issued by the IRS). After the transfer the parties intend that their respective IRAs will be separate property under state law. The IRS made the following ruling regarding the proposed transaction: 1) Community property law is given effect here, in that it is proper to recognize B's community property interest in each of the IRAs. IRC §408(g), which provides the IRC §408 is applied without regard to community property laws is apparently limited to tax issues. For example, a distribution from an IRA to the IRA owner is taxable to that individual, regardless of whether a portion of that distribution is attributable to the community property share of the individual's spouse. 2) The mere classification of A's IRAs as marital property to recognize B's community interest in the IRAs does not trigger taxation. 3) The transfer of B's community property share of the IRAs to her own IRA will represent a taxable distribution to A, pursuant to IRC §408(d)(1). Regardless of community property interests under applicable state law, the owner of an IRA account is deemed to be the individual in whose name the account is established (A in this case). Thus, any distributions from the IRA are to be taxed as if the owner is the sole owner of the IRA. Thus, the transfer of one-half of the IRAs to a B's IRA is treated as a taxable distribution to A. IRC §408(d)(6) provides an exception to taxation where an amount in an IRA is transferred to the IRA owner's former spouse pursuant to a divorce decree. The IRS merely cited §408(d)(6) without explaining why it is not applicable. However, implied the IRS' ruling is that §408(d)(6) is not applicable because the transfer is not pursuant to divorce. A transfer executed for the purpose of dividing the IRA to recognize community property rights so that the property can be reclassified as separate property is not within the scope of §408(d)(6).

IRS field office must request technical advice on conversions to cash balance plans (added September 17, 1999). On September 15, 1999, Carol Gold, the Director of the Employee Plans Division of the IRS National Office sent a directive to the EP/EO Division Chiefs in the field. The directive requires that the field offices request technical advice from the National Office before closing any determination letter or examination cases which involve the conversion of a traditional defined benefit plan into a cash balance defined benefit plan. For this purpose, a cash balance plan is any defined benefit plan that defines benefits as a single-sum distribution amount, regardless of what the plan is called. This would include personal account plans, pension equity plans, life cycle plans, cash account plans, and similar designations. The directive is in response to the recent spate of litigation and Congressional inquiries into cash balance conversions. The directive remains in effect until further notice.

Plan may refuse to honor IRS tax levy against plan benefits if participant is not presently entitled to distribution; IRS may elect distribution on participant's behalf if participant has present right to distribution (added August 2, 1999; modified September 14, 1999). Two recent internal memoranda at the IRS shed light on IRS' approach to tax levies against retirement benefits. In FSA 199930039, a field service advice memorandum issued by the IRS National Office, the plan administrator was refusing to honor the levy because the participant was not currently eligible for distribution under the terms of the plan. The IRS advised the field office that the plan may refuse to honor the levy until the participant is eligible for distribution. Nonetheless, the levy is valid with respect to the participant's vested benefits under the plan, because a levy reaches a present right (i.e., vested interest) against future benefits. Therefore, the levy will not be released regardless of the taxpayer's current inability to receive an immediate distribution from the plan. The IRS National Office recommended that the field office inform the plan in writing that the levy is not being released and that any funds which become distributable to the taxpayer are subject to the levy. In CCA 199936042, a Chief Counsel Advice memorandum, the participant was eligible to elect early retirement under the plan. The IRS' position under such circumstances is that the IRS may step in the participant's shoes and make the early retirement election! Where spousal consent is required for distribution in a form other than a qualified joint and survivor annuity, the IRS may levy only on the joint and survivor annuity payments, and may not elect another form of benefit without the spouse's consent.

IRS guidance on repeal of section 415(e) limit is released (added August 17, 1999). Notice 99-44 provides Q&A guidance on the repeal of section 415(e). Section 415(e) limits an employee's overall benefits under a defined contribution plan and a defined benefit plan maintained by the same employer (treating related employers under tax code section 414 as the same employer). The repeal is effective for limitation years beginning on or after January 1, 2000. Here is a brief listing of the key points made in Notice 99-44.

• 1) If a plan incorporates the section 415 limits by reference, then the repeal automatically takes effect as of the first day of the first limitation year beginning on or after January 1, 2000. This might result in an automatic increase in a participant's benefits payable under a defined benefit plan. If an employer wants to delay the automatic increase in benefits, to give itself time to study the funding costs and qualification issues associated with an increase in benefits, the employer would have to amend the plan before the effective date of the repeal. Q&A-7 prescribes a model amendment for this purpose.
• 2) If a plan is not described in 1) (i.e., the plan contains provisions that describe the section 415(e) limit), an increase in benefits arising from the repeal of section 415(e) would not necessarily be automatic. The terms of the plan would have to be analyzed. Generally, if the plan doesn't simply cross-reference the limit, but rather describes language that limits benefits in a manner that reflects the section 415(e) limit, an automatic increase would usually not occur in the absence of a plan amendment. For this type of plan, the employer has a choice: a) wait until the plan is actually amended to start administering the plan without taking into account section 415(e), or b) ignore section 415(e) in operation, pursuant to the GUST remedial amendment period guidelines in Rev. Proc. 99-23, and adopt a conforming amendment by the end of the remedial amendment period. If the employer takes the first approach, there may be qualification issues to consider if the amendment is not made retroactively effective to the statutory effective date of the repeal of section 415(e). See 4) and 5) below.
• 3) Benefits of employees and retirees may be increased to reflect the repeal of section 415(e), but only if the individual still has an accrued benefit left in the plan. In other words, if the individual was already paid out their entire accrued benefit (e.g., lump sum payment) before the effective date of the repeal, there is no increase permitted. Q&A-3 and Q&4 of the notice prescribe rules for benefit increases for retirees and former employees. A benefit increase may not reflect adjustments for benefits received prior to the 2000 limitation year that were limited by section 415(e). In other words, the repeal of section 415(e) only affects annual benefits prospectively. Nondiscrimination testing requirements relating to plan amendments (Reg. section 1.401(a)(4)-5) and relating to benefit increases for former employees (Reg. section 1.401(a)(4)-10(b)), are deemed satisfied if the benefit increases occur as of the effective date of the section 415(e) repeal and the group which receives the increases consists of: a) all current and former employees who have an accrued benefit under the plan as of the effective date of the repeal, or b) all employees participating in the plan who have at least one hour of service after the effective date of the repeal.
• 4) Nondiscrimination testing may be affected by how the repeal of section 415(e) is handled by the plan. If the repeal is taken into account as of the effective date of the repeal, then a plan which is otherwise designed to be a safe harbor plan under the section 401(a)(4) nondiscrimination testing rules continues to satisfy the safe harbor. However, if the repeal is delayed, either by adoption of the plan amendment described in 1) above, or by continuing to operate the plan in accordance with plan provisions that state the section 415(e) limitation, as described in 2) above, then the plan is not a safe harbor plan under section 401(a)(4) unless the continued application of section 415(e) is applied only to highly compensated employees. See Q&A-5 and Q&A-10 of the notice.
• 5) Any exception from the qualification rules that is provided in order to satisfy section 415 is not applicable to a plan which limits an employee's annual additions under a defined contribution plan or accrued benefit under a defined benefit plan solely by reason of the continued operation of the section 415(e) limit after the effective date of the repeal. For example, if a 401(k) plan refunds elective deferrals to correct excess annual additions, but the excess determined by the plan exists solely because of the continued operation of the plan's 415(e) provisions after the effective date of the repeal, the refund would violate the qualification requirements. See Q&A-8 of the notice. The same issues arise if a defined contribution plan determines the 25% compensation limit under section 415(c) by failing to take into account the SBJPA amendments to the compensation definition under section 415(c)(3). The SBJPA amended compensation to include elective deferrals under section 402(g) (i.e., elective deferrals under 401(k) plans, 403(b) plans, SARSEPs and SIMPLEs), so that the 25% limit is based on "gross" compensation. If the plan continues to use net compensation, it will calculate a lesser 415 limit. Q&A-9 of Notice 99-44 provides relief for plans that corrected excess annual additions on the basis of the net compensation definition for limitation years that end on or before November 30, 1999.

DOL proposes rules for requesting SPDs, SMMs and other plan documents and for assessing civil penalty for noncompliance (added August 12, 1999). The Taxpayer Relief Act of 1997 (TRA '97) eliminated the requirement that the plan administrator file copies of summary plan descriptions (SPDs) and summaries of material modifications (SMMs) with the Department of Labor (DOL). Instead, DOL may request a copy of these documents, pursuant to ERISA §104(a)(6). TRA '97 also added ERISA §502(c)(6), which imposes a civil penalty on the plan administrator for a failure to comply with such a request. The penalty is $100 per day, with a maximum penalty of $1,000 per failure. Proposed regulations issued on August 5, 1999, implement the procedures for DOL's request for documents and the assessment of penalties for a failure to comply with the request and to petition for relief due to circumstances beyond the reasonable control of the plan administrator. See Prop. DOL Reg. §2520.104a-8, §2560.502c-6, §§2570.110-2570.121, published in 64 F.R. 42797.

IRS provides more guidance on correcting operational failures in qualified plans (added August 6, 1999). Rev. Proc. 99-31 supplements the guidance in Rev. Proc. 98-22, regarding the Employee Plans Compliance Resolution System (EPCRS). The guidance addresses specific correction methods for various operational failures. The correction methods supplement those found in Appendix A of Rev. Proc. 98-22. Appendix A prescribes correction methods under the Standardized VCR Procedure (SVP) for seven types of operational failures. Any of the correction methods in Rev. Proc. 99-31, as well as any of the SVP correction methods set forth in Appendix A of Rev. Proc. 98-22, may be used to correct operational failures under any of the EPCRS programs - APRSC, VCR or Walk-in CAP. Thus, if a plan sponsor uses the APRSC program to fix an operational failure on its own, and uses one of the correction methods set forth in Rev. Proc. 99-31 or Appendix A of Rev. Proc. 98-22, the IRS will treat the correction as a reasonable and appropriate correction for the operational failure. Rev. Proc. 99-31 also provides alternatives for calculating earnings adjustments on corrective contributions. Use of any of these prescribed earnings adjustment methods is treated as a reasonable method of determining earnings, as prescribed by section 6.02(3)(a) of Rev. Proc. 98-22. The following list briefly summarizes the guidance found in Rev. Proc. 99-31.

• Correcting ADP and ACP test violations.In lieu of making qualified nonelective contributions (QNECs) to fix ADP or ACP violations that were not corrected within the 12-month regulatory correction period, the employer may use a "one-on-one" contribution method. Under this approach, the excess amounts determined under the ADP or ACP test are distributed to the highly compensated employees (HCEs), even though the 12-month correction period has passed, and the employer contributes an equal amount for the benefit of the nonhighly compensated employees (NHCs).
• Excluding eligible employee from allocation.Where an eligible employee was excluded from the allocation of a discretionary employer contribution to profit sharing plan or stock bonus plan, the contribution may be reallocated to include the excluded employee under certain circumstances. That means the amount is removed from the accounts of the employees who shared in the allocation and reallocated to the excluded employee. Under this method, the employer is not required to make a corrective contribution, except to the extent the amount taken from the other employees' accounts is not sufficient to restore the excluded employee, either because of the method of determining earnings adjustments or because part of the amount to be reallocated has been distributed from the plan.
• Improper forfeitures.Guidance is provided on correcting improper forfeitures that occur because of misapplication of the plan's vesting schedule. Usually the employer will either make a corrective contributed for the forfeited employee or use the reallocation method described above.
• Overpayments to participants because of section 415 violations.Overpayments to participants because of a violation of the section 415 limits may be corrected either by having the participant repay the overpayment to the plan or by reducing future payments. Where the overpayment cannot be recouped from the participant, the employer can make a corrective contribution to the plan. A special correction is provided for defined contribution plans that exceeded the limit with respect to a terminated participant who has already received distribution of his elective deferrals and after-tax employee contributions made for the year in which the excess arose, under which nonvested employer contributions can be forfeited to correct the excess annual additions.
• Other overpayments to participants.Other types of overpayments, such as a distribution to a participant of amounts incorrectly allocated to the participant because of misapplication of the compensation dollar limit under section 401(a)(17), may be corrected by having the participant return the overpayment to the plan, in the same manner described above for section 415 excesses. To the extent the overpayment is not recouped, the employer may contribute the difference.
• Violating compensation dollar limit.If a defined contribution plan has made allocations on the basis of compensation in excess of the dollar limit under IRC §401(a)(17), the excess allocation may be reallocated or used to reduce future employer contributions. Alternatively, the employer may use the Walk-in CAP procedure to amend the plan to increase the contribution formula for other employees.
• Retroactive addition of hardship provisions.The Walk-in CAP procedure may be used to retroactively amend the plan to add a hardship withdrawal procedure, where a defined contribution plan has made a hardship distributions without an authorizing plan provision.
• Calculation of earnings on corrective contributions.Earnings on corrective contributions to a defined contribution plan may be made under various flexible methods that will reduce the expense of calculating investment return on the corrective contribution and allocating the earnings to account balances.
• Effective date.Rev. Proc. 99-31 is generally effective January 1, 2000. However, plan sponsors may rely on this new correction guidance for any corrections made since the March 9, 1998, publication of Rev. Proc. 98-22.

Non-401(k) plans might be able to add safe harbor after first day of plan year (added October 25, 1999). IRS may be backing off on a position they were taking earlier this year. The issue involves a non-401(k) profit sharing plan for which the employer is adding a 401(k) feature after the first day of the plan year, and would like that 401(k) arrangement to be a safe harbor 401(k) for that first year. Previously we reported that IRS was taking the position the 401(k) arrangement could not be a safe harbor for that first year because the notice would have to be given at least 30 days before the first day of the plan year for which that was to be effective. The IRS was not going to recognize the added 401(k) arrangement as a new "plan" for purposes of the notice requirement under tax code section 401(k)(12). Instead, the employer had to establish a separate 401(k) plan, which could have an effective date no earlier than when it was adopted, in order to have a 401(k) safe harbor for that first year. The separate 401(k) plan could then be merged into the existing profit sharing plan thereafter. Well, due to a great deal of negative comments from the pension community, IRS is apparently rethinking this position, according to Dick Wickersham (speaking at the ASPA Conference in Washington, D.C. today). Guidance to be issued in the future probably will permit the new 401(k) arrangement to be added to the existing profit sharing plan, and will permit the annual notice requirement to be satisfied no later than the effective date of that 401(k) arrangement, as if it were a separate plan. This is a logical position, and is welcomed by the pension community. Mr. Wickersham also indicated that sponsors who add safe harbor 401(k) arangements to existing profit sharing plans before the publication of such guidance would be given retraoctive relief. Of course, until IRS actually publishes something, there is no guarantee the position will stick. But the fact that Mr. Wickersham chose to announce this position at the ASPA Conference, where over 1,400 pension professionals are attending, is significant.

Board resolution established 401(k) plan's termination date (added August 9, 1999). In Private Letter Ruling 199931047, the resolution of the legal issues turned on the effective date of a 401(k) plan's termination. The IRS ruled that the effective date of the termination was determined by the Board of Directors' resolution. The company had terminated its 401(k) plan and wanted to make distribution pursuant to section 401(k)(10). Section 401(k)(10) allows distribution of 401(k) deferrals pursuant to plan termination only if there is no successor plan covering the participants of the terminated 401(k) plan. A plan is not a sucessor plan unless it is maintained by the same employer that maintained the terminated 401(k) plan. To determined "same employer" the controlled group rules apply. Since the termination date established in the Board resolution was after the acquisition of the company's stock by its new parent company, the parent company's defined contribution plan is a potential successor plan because the parent company is part of a controlled group with the sponsor of the terminated 401(k) plan. The company was relying on the exception under section 1.401(k)-1(d)(3) of the Income Tax Regulations, which states that a plan is not a successor plan if fewer than 2% of the participants in the terminated 401(k) plan are eligible for the other plan during the 24 month period which begins 12 months before the 401(k) plan's termination date. To count the 24-month period, the IRS ruled that the termination date is the date established in the Board resolution.

Conference bill with pension provisions passed by Congress (modified August 7, 1999). On August 5, 1999, both Houses of Congress passed the Taxpayer Refund and Relief Act of 1999 (TRRA 1999). The bill passed the House by a vote of 221-206 and passed the Senate by a vote of 50-49, not nearly close enough to override the President's promised veto. The votes were primarily on party lines. The Republicans plan to take their case for the legislation directly to the taxpayers prior to actually sending the bill to the President. Although a veto is assured, there is still the possibility of compromise on tax legislation, in which case the pension provisions contained in this bill, which are generally not considered to be controversial, would become law. The following summary lists the pension provisions in the TRRA 1999. Unless otherwise specified, the provisions are effective after December 31, 2000 (or years beginning after such date where appropriate).

1) increases in the following dollar limits - compensation limit under section 401(a)(17) from $160,000 to $200,000, section 415(b) annual benefit dollar limit for defined benefit plans from $130,000 to $160,000 (with reduction only if benefit commences before age 62, rather than before social security retirement age; and an increase in the dollar limit if benefits commence after 65, rather than after social security retirement age), section 415(c) annual additions dollar limit for defined contribution plans from $30,000 to $40,000, elective deferral dollar limit under section 402(g) from $10,000 to $15,000 (starting with $11,000 in 2001, increasing $1,000 per year until it is at $15,000 in 2005), annual deferral limit for section 457 plans from $8,000 to $15,000 (starting with $11,000 in 2001, increasing $1,000 per year until it is at $15,000 in 2005), elective deferral limit for SIMPLE plans from $6,000 to $10,000 (starting with $7,000 in 2001 and increasing $1,000 per year until it reaches $10,000 in 2004) - all of these limits would be subject to indexing in $5,000 increments for the compensation dollar limit and the DB dollar limit under section 415, in $1,000 increments for the DC dollar limit under section 415, and in $500 increments for the other limits;

2) annual additions compensation limit for defined contribution plans, under section 415(c), increases from 25% to 100%;

3) permit sole proprietors, partners, and S corporation shareholders who are plan participants to receive participants loans;

4) simplify the key employee definition for top heavy purposes by eliminating "top 10 owner test," increasing the compensation requirement for the officer test to $150,000, repealing family attribution to determine ownership for key employee purposes, and eliminating the 4-year lookback to determine who is a key employee;

5) matching contributions would count toward satisfying the top heavy minimum contribution, and safe harbor 401(k) plans that provide the safe harbor matching contribution would be deemed to satisfy the top heavy rules;

6) top heavy testing would use only a 1-year lookback, rather than a 5-year lookback, to include prior distributions from the plan (except in-service distributions would still be subject to the 5-year lookback);

7) top heavy minimum accrued benefits under a defined benefit plan would be determined without regard to years of service for which the plan isfrozen;

8) "Roth 401k" arrangements would be permitted (i.e., employee foregoes the income tax deduction for the elective deferral to the 401k plan and in exchange receives tax-free distributions attributable to the elective deferral (and income attributable to such deferral), provided the plan separately accounts for the contributions (called "qualified plus contributions") and the withdrawals are taken only after 5 taxable years from the year in which the first Roth 401k contributions are deposited by the employee and only if withdrawn after age 59-1/2 or because of death or disability - qualified plus contribution accounts could be rolled over only to another qualified plan that permits such accounts or to a Roth IRA and qualified plus contributions would be treated as elective deferrals for purposes of applying the nondiscrimination test (ADP test);

9) employers could deduct 401k contributions in full without reducing the deduction limit for other employer contributions to profit sharing or stock bonus plans (i.e., 15% deduction limit would still apply to other employer contributions, such as matching contributions or discretionary nonelective contributions), and the 15% and 25% deduction limits under section 404(a)(3), 404(a)(7) and 404(a)(9) would be determined by including elective deferrals in the definition of compensation;

10) reduced PBGC premiums ($5, instead of $19, per participant) for a new plan of a small employer (100 or fewer employees) who has not maintained a Title IV plan within the last three years, phase-in of variable rate premium for the first six plan years of a new plan maintained by an employer (of any size) who has not maintained a Title IV plan within the last three years, and a cap of $5 per participant on the variable rate premiums for plans with fewer than 25 participants;

11) elective deferral limits under section 402(g) and 457 increased by 50% for employees who have attained age 50, and the additional contribution would not be included in discrimination testing nor in section 415 limits (increase of limit is only 10% for 2001, 20% for 2002, 30% for 2003, 40% for 2004, then 50% thereafter);

12) reduction of the excise tax on failure to make required minimum distributions from 50% to 10%;

13) simplification of rules relating to post-death minimum distributions so that all post-death distributions are determined under the rules that currently apply to participants who die before the required beginning date, and surviving spouses could postpone minimum distributions until April 1 following the year in which the spouse reaches age 70-1/2;

14) more portability for benefits - rollovers would be permitted between all types of employer-sponsored plans (qualified plans, 403(b) plans, 457 plans), after-tax employee contributions could be rolled over from qualified plans to IRAs or other qualified plans, and taxable IRA funds could be rolled into qualified plans, 403(b) plans or 457 plans, even if the IRA is not a conduit IRA; surviving spouses would be able to rollover to qualified plans, 403(b) plans, or 457 plans, as well as to IRAs; section 72(t) penalty for pre-59-1/2 distributions would apply to rollover accounts held in 457 plans that are attributable to qualified plans, 403(b) plans or IRAs; section 402(f) notice regarding rollovers would be expanded to cover 403(b) plans and 457 plans; IRS would have authority to extend 60-day rollover period for hardship cases;

15) defined contribution plans would be allowed to eliminate any form of periodic distribution, so long as a lump sum distribution is available, except as provided in regulations (does not eliminate the requirement for a pension plan to include a qualified joint and survivor annuity as an optional form of benefit);

16) the "same desk" rule would be eliminated for purposes of determining whether an employee has a distributable event from a 401k plan (i.e., would simplify issues relating to whether distributions could be made from a 401k plan maintained by a company being acquired by another company that will offer employment to the seller's employees but will not maintain the seller's plan);

17) repeal of the "150% of current liability" funding limit for post-2003 plan years (with phase-out in earlier years);

18) PBGC's missing participant program would be expanded to cover defined contribution plans at the election of the plan sponsor;

19) no excise tax would apply to nondeductible contributions made by an employer to a defined benefit plan, to the extent the contributions do not exceed the termination funding liability, even for defined benefit plans that cover fewer than 100 participants;

20) expanded notice requirements under ERISA section 204(h) (relating to significant reduction in future benefit accruals), with an excise tax imposed on employer for failure to provide certain information in the case of a plan that has 100 or more participants;

21) repeal of the multiple use test for 401k plans;

22) Form 5500-EZ would be made available to plans that cover 25 or fewer employees, so long as minimum coverage requirements are satisfied, and the employer is not part of a controlled group or affiliated service group and does not receive the services of leased employees;

23) deferral limits under section 457 plans would no longer be reduced by deferrals made to section 403(b) and 401(k) plans;

24) waiver of user fee for determination letter requests made by small employers (defined in manner similar to SIMPLE rules), but only for requests made in the first five years of the plan's existence;

25) accelerated vesting requirements on matching contributions which essentially impose the top heavy vesting standards on matching contributions, regardless of whether the plan is top heavy;

26) Treasury would be required to amend its regulations regarding 401(k) hardship withdrawals to reduce the suspension period for the participant's deferrals from 12 months to 6 months;

27) QDRO tax rules would be applied to section 457 plans, so that spouses who are awarded benefits under a QDRO would be taxed on the distributions for federal tax purposes;

28) relief from tax code section 411(d)(6) with respect to optional forms of benefit attributable to benefits transferred under an elective transfer transaction (expanding the current "elective transfer" exception found in section 1.411(d)-4, Q&A-3, of the Income Tax Regulations by allowing such transactions without regard to whether an immediate distribution is available and to permit use of this rule in mergers and similar transactions, so long as the participant is consenting to the transfer, is notified of the consequences, and, if the QJSA rules apply, the spouse is consenting);

29) rollovers would be excluded from the involuntary cash-out limit determination (e.g., a participant could be involuntarily cashed out so long as his non-rollover vested account is $5,000 or less, even though the total vested account exceeds $5,000 when the rollover is taken into account);

30) the maximum exclusion allowance (MEA) under section 403(b)(2) would be repealed, so that section 403(b) plan participants would be limited only by the section 402(g) limit and the section 415 limit;

31) governmental section 457 plans would no longer be subject to a "made available" rule for distributions so that benefits under a section 457 plan, like benefits under qualified plans and section 403(b) plans, would be taxable only when actually distributed;

32) multiemployer defined benefit plans would no longer be subject to the 100% of compensation limit under section 415(b) (i.e., benefits under a multiemployer plan would be limited only by the dollar limit);

33) ESOP dividends would be deductible under section 404(k) even if the employee is given the option to reinvest the dividend in the plan rather than having the dividend distributed;

34) plans could show compliance with nondiscrimination testing under section 401(a)(4) or coverage under 410(b) using a facts and circumstances test, provided a determination letter was requested and other conditions prescribed by IRS are satisfied;

35) one-participant plans that are eligible to file Form 5500-EZ would be exempt from filing if assets were $250,000 or less (current rule is $100,000 or less);

36) IRA contributions limits would be increased - phased-in to $5,000 by 2006 with COLAs in $100 multiples thereafter, and individuals who have reached age 50 would be able to contribute 150% of the IRA limit (phased in from 2001 through 2005, starting with 110%, rather than 150%);

37) AGI limits for Roth IRA contributions would be raised, and Roth IRA conversions would be permitted for married couples if the AGI on the joint return were $200,000 (rather than $100,000);

38) Education IRAs would be redesignated as Education Savings Accounts, the annual contribution limit would be raised from $500 to $2,000, and elementary and secondary school expenses would be added to the definition of qualified education expenses;

39) withholding on nonperiodic plan distributions that are not eligible rollover distributions would be raised from 10% to 15%;

40) prohibited allocation rules would be added for allocating employer securities under ESOPs maintained by S corporations, to limit the amount allocated to certain significant owners.

Dropped in Conference was a proposal to extend the maximum notice period for plan distributions from 90 days to 12 months before the distribution date, a proposal for SAFEs (a SIMPLE-version of defined benefit plans), a proposal to expand the ERISA definition of an excess benefit plan, a proposal to provide relief from the ERISA section 502(l) penalty for fiduciary breaches, and a proposal to eliminate the requirement to provide summary annual reports.

Plan amendments would not be required until the end of the 2003 plan year. If these proposals are enacted in this session, it is possible that the IRS will extend the GUST remedial amendment period to accomodate these changes as well.

Summer 1999 Issue of ERISA Views is out!The latest issue of ERISA Views, TRI Pension Services' quarterly newsletter, has been published. The focus topic is on the new rollover restrictions on certain hardship withdrawals from 401(k) plans. The current developments section features the items summarized below, but with more details. To order ERISA Views, click on "Newsletter" (left of this page) and follow the instructions to print out an order form.

IRS confirms issue of adding a safe harbor 401(k) after the first day of the normal plan year cycle (added June 10, 1999). On April 13, 1999, we posted an item on this What's New page (see below) explaining the IRS National Office's position on adding a safe harbor 401(k) after the first day of the normal plan year cycle. At the Cincinnati Bar Association's Employee Benefits Conference today, Dick Wickersham from the IRS confirmed this information. Mr. Wickersham's comments were made in a Q&A session moderated by Sal Tripodi of TRI Pension Services. Here is a summary of Mr. Wickersham's comments.

1) If there is no existing plan, an employer can start a safe harbor 401(k) at any time. However, if the plan is adopted after the date the normal plan year would begin, the first plan year must be a short plan year. (Example - new safe harbor 401(k) adopted effective July 1, 1999, with an initial short plan year ending December 31 and a normal 12-month plan year cycle ending every December 31.)

2) If there is an existing non-401k plan, and the employer wants to install a safe harbor 401(k) arrangement after the first day of the normal plan year cycle, the arrangement may NOT be added to the existing plan. However, the employer may start a separate plan that is a safe harbor 401(k) plan, which can have an initial short plan year, as described in 1) above. The two plans could then be merged effective on the beginning of the next full plan year.

Example. Employer maintains non-401k profit sharing with plan year ending December 31. As of July 1, 1999, employer installs a separate safe harbor 401k plan. The first year of that new 401k plan runs from July 1 through December 31, 1999. Effective January 1, 2000, the safe harbor 401k plan is merged with the non-401k profit sharing plan, to form a single plan, with a December 31 plan year, which contains the safe harbor 401k arrangement and the regular profit sharing plan component.

3) If there is an existing 401k plan, then the plan may not be amended to convert to safe harbor on any date other than the first day of a plan year. In addition, a separate 401k plan may NOT be established to add a safe harbor 401(k) arrangement covering the same employees because it would be treated as a successor to the existing 401k plan. The only way the employer could start a safe harbor 401k before the next plan year starts is to change the plan year and start the safe harbor with the first 12-month plan year following such change. This would not be a very practical alternative for an employer.

Example. Existing 401k plan has a December 31 year end. Effective July 1, 1999, the employer amends the plan year to a June 30 period, creating a short plan year ending June 30, 1999. The amended plan could be a safe harbor for the 12-month plan year starting July 1, 1999. But now the employer has moved its 401k plan onto a noncalendar plan year.

Plan amendments to change ADP/ACP testing methods will have to be made by first day of plan year after GUST remedial amendment period ends (added June 10, 1999). Speaking at the Cincinnati Bar Association's Employee Benefits Meeting, Dick Wickersham from IRS discussed the issue of when a 401k plan would have to be amended to change its ADP/ACP testing method. Notice 98-1 requires that the testing method be specified in the plan (although operational compliance is permitted during the GUST remedial amendment period). When will such an amendment have to be made? Mr. Wickersham indicated that current thinking is to require the amendment to be made by the first day of the plan year for which the change is required. For example, suppose a 401k plan is amended in the 2000 plan year to adopt the prior year testing method. For the 2003 plan year, the employer decides it would like to switch to the current year method. If IRS goes with this interpretation, the employer would have to adopt that amendment by the first day of the 2003 plan year. Mr. Wickersham did, however, indicate that this is simply a working proposal in what will become a regulation project. The IRS is very receptive to feedback on this issue. Sal Tripodi of TRI Pension Services moderated the Q&A session, and suggested that the testing method amendment should be permitted at any time during the plan year and even during the 12-month regulatory correction period which follows the plan year. With the limitations prescribed by Notice 98-1 on switching from the current year method to the prior year method once the GUST remedial amendment period has ended, there will be little possibility for abuse here. Furthermore, there are many choices made by plan administrators in operation with regard to ADP and ACP testing during the 12-month correction period, and the decision to amend the plan to change the testing method should be treated as another one of those decisions. If you agree, or have other suggestions relating to the flexibility for amending the testing method, let IRS know your thoughts!

Safe harbor 401(k) plan cannot be terminated before end of plan year (added June 10, 1999). Dick Wickersham from the IRS, speaking at the Cincinnati Bar Association's Employee Benefits Conference, stated that the IRS views the safe harbor notice to employees as a promise to keep the 401k in effect throughout the 12-month plan year. Thus, an employer cannot simply discontinue the arrangement before the normal year end.

Opening of master/prototype program probably not until this Fall (added June 10, 1999). Jim Flannery from the IRS spoke at the Cincinnati Bar Association's Employee Benefits Conference today about the pending revision of the IRS' master/prototype and regional prototype procedures. The two programs, currently handled in Rev. Proc. 89-9 (master/prototype) and Rev. Proc. 89-13 (regional prototype) will be combined into a single program. Under the revised procedure, all sponsoring organizations will sponsor master/prototypes, thereby discontinuing the regional prototype designation. The "best of both procedures" will be adopted in the uniform program. Mr. Flannery indicated that the IRS will probably not issue the revised procedure earlier than July 31, and applications for full GUST review will probably not be accepted before the end of September. Furthermore, the deadline for master/prototype sponsors to submit their revised plans will not occur until sometime in 2000 (December 31, 1999, will NOT be the deadline). We'll keep you posted!

No action needed by close of taxable year to establish profit sharing contribution (added June 7, 1999) In a National Office Field Service Memorandum, FSA 199922005, the IRS discusses whether an employer must establish its contribution liability under a discretionary profit sharing plan by the end of the taxable year in order to receive a deduction for the contribution for that year. The ruling confirms that the contribution liability need NOT be established by the end of the taxable year. So long as the amount is contributed by the due date (including extensions) for filing the employer's federal income tax return for the taxable year, as permitted under section 404(a)(6) of the tax code, and the amount is treated as made "on account of" the taxable year (i.e., allocated in an manner consistent with a contribution made on the last day of such year), the contribution satisfies the requirements under section 404 for deductibility for that taxable year. This is true for both accrual and cash basis taxpayers. The IRS noted that Revenue Ruling 71-38, which provided that an employer had to a establish a "fact of liability" prior to the close of its taxable year, was obsoleted by Revenue Ruling 84-50.

Automatic extension for making IRA recharacterization election (added May 29, 1999) Announcement 99-57 from the IRS reminds taxpayers of the automatic extension available under section 301.9100-2(b) of the Income Tax Regulations for making IRA recharacterization elections under section 408A(d)(6) of the tax code. Section 408A(d)(6) permits a taxpayer to recharacterize a traditional IRA contribution as a Roth IRA contribution or vice versa, or to reverse a conversion of traditional IRA to a Roth IRA. To qualify for the extension under section 301.9100-2(b), the taxpayer must have made a timely filing of his income tax return, but simply failed to make the election by that date. The extension provides six months from the unextended due date of the return and corrective action must be taken within the 6-month period from such unextended due date. Example. Janis converted her traditional IRA into a Roth IRA on December 20, 1998. It was later determined that her adjusted gross income for 1998 exceeded $100,000, so she was not eligible for the conversion. Janis filed her 1998 tax return by April 15, 1999. No extension was obtained on filing the tax return. However, Janis did not recharacterize the Roth IRA that was created by the conversion into a traditional IRA in order to reverse the failed conversion. Since Janis timely filed her 1998 tax return, she may rely on §301.9100-2(b) to recharacterize the Roth IRA as a traditional IRA by October 15, 1999 (i.e., 6 months after the unextended due date of her 1998 tax return). If she makes the recharacterization by that date, she will reverse the tax consequences of the failed conversion to the Roth IRA. Note that Janis will need to file an amended 1998 tax return to reflect the tax effect of the recharacterization election - i.e., the reversal of the tax consequences triggered by the original conversion. Janis does not have to file the amended return by October 15, 1999. Rather, she must file the amended return within the normal deadline for amended returns. The October 15, 1999, deadline applies only to the corrective action (i.e., the recharacterization) needed to reverse the failed conversion

IRS temporary closes master/prototype and regional prototype programs in anticipation of new procedures (April 23, 1999). Effective May 10, 1999, the IRS will temporarily close its approval program for master/prototype plans and regional prototype plans. This temporary closing is in anticipation of a "new and improved" procedure that will combine the two programs and will permit applications for consideration of all the GUST (GATT, USERRA, SBJPA, TRA '97) law changes, including those that become effective in post-1998 plan years. Any applications that are pending with the IRS as of May 10 can be withdrawn or processed. However, if the sponsor chooses to have the application processed, the letter issued on the plan will cover only the pre-1999 law changes.

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