[Senate Report 108-266]
[From the U.S. Government Publishing Office]
Calendar No. 516
108th Congress Report
SENATE
2d Session 108-266
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NATIONAL EMPLOYEE SAVINGS AND TRUST EQUITY GUARANTEE ACT
_______
May 14, 2004.--Ordered to be printed
_______
Mr. Grassley, from the Committee on Finance, submitted the following
R E P O R T
together with
ADDITIONAL VIEWS
[To accompany S. 2424]
The Committee on Finance, having considered an original
bill (S. 2424) to amend the Internal Revenue Code of 1986 and
the Employee Retirement Income Security Act of 1974 to protect
the retirement security of American workers by ensuring that
pension assets are adequately diversified and by providing
workers with adequate access to, and information about, their
pension plans, and for other purposes, reports favorably
thereon and recommends that the bill do pass.
Contents
Page
I. Legislative Background...................................... 4
II Explanation of the Bill..................................... 5
Title I. Diversification of Pension Plan Assets............. 5
A. Defined Contribution Plans Required To Provide
Employees With Freedom To Invest Their Plan Assets
(sec. 101 of the bill, new sec. 401(a)(35) of the
Code, and new sec. 204(j) of ERISA)................ 5
B. Notice of Freedom To Divest Employer Securities or
Real Property (sec. 102 of the bill, new sec. 4980H
of the Code, and new sec. 104(d) of ERISA)......... 14
Title II. Information To Assist Pension Plan Participants... 16
A. Periodic Pension Benefit Statements and Investment
Education (secs. 201-202 of the bill, new sec.
4980I of the Code, and secs. 104 and 105(a) of
ERISA)............................................. 16
B. Material Information Relating to Investment in
Employer Securities (sec. 203 of the bill, new sec.
4980H of the Code, and secs. 104 and 502 of ERISA). 22
C. Fiduciary Rules for Plan Sponsors Designating
Independent Investment Advisors (sec. 204 of the
bill and new sec. 404(e) of ERISA)................. 24
D. Employer-Provided Qualified Retirement Planning
Services (sec. 205 of the bill and sec. 132 of the
Code).............................................. 26
Title III. Protection of Pension Plan Participants.......... 28
A. Notice to Participants or Beneficiaries of Blackout
Periods (sec. 301 of the bill, new sec. 4980J of
the Code, and sec. 101(i) of ERISA)................ 28
Title IV. Other Provisions Relating to Pensions............. 32
A. Provisions Relating to Pension Plan Funding......... 32
1. Replacement of interest rate on 30-year Treasury
securities used for certain pension plan
purposes (secs. 401-408 of the bill, secs.
401(a)(36), 404, 412, 415(b), and 417(e) of the
Code, and secs. 205(g), 206, 302, and 4006 of
ERISA)......................................... 32
2. Updating deduction rules for combination of
plans (sec. 409 of the bill and secs. 404(e)(7)
and 4972 of the Code).......................... 45
B. Improvements in Portability and Distribution
Provisions......................................... 47
1. Purchase of permissive service credit (sec. 411
of the bill and secs. 403(b)(13), 415(n)(3),
and 457(e)(17) of the Code).................... 47
2. Rollover of after-tax amounts (sec. 412 of the
bill and sec. 402(c)(2) of the Code)........... 49
3. Application of minimum distribution rules to
governmental plans (sec. 413 of the bill)...... 50
4. Waiver of 10-percent early withdrawal tax on
certain distributions from pension plans for
public safety employees (sec. 414 of the bill
and sec. 72(t) of the Code).................... 51
5. Rollovers by nonspouse beneficiaries of certain
retirement plan distributions (sec. 415 of the
bill and and secs. 402, 403(a)(4), 403(b)(8),
and 457(e)(16) of the Code).................... 52
6. Faster vesting of employer nonelective
contributions (sec. 416 of the bill, sec. 411
of the Code, and sec. 203 of ERISA)............ 54
7. Allow direct rollovers from retirement plans to
Roth IRAs (sec. 417 of the bill and sec.
408A(e) of the Code)........................... 55
8. Elimination of higher early withdrawal tax on
certain SIMPLE plan distributions (sec. 418 of
the bill and sec. 72(t) of the Code)........... 57
9. SIMPLE plan portability (sec. 419 of the bill
and secs. 402(c) and 408(d) of the Code)....... 58
10. Eligibility for participation in eligible
deferred compensation plans (sec. 420 of the
bill).......................................... 59
11. Benefit transfers to the PBGC (sec. 421 of the
bill, sec. 401(a)(31) of the Code, and sec.
4050 of ERISA)................................. 60
C. Administrative Provisions........................... 62
1. Improvement of Employee Plans Compliance
Resolution System (sec. 431 of the bill)....... 62
2. Extension to all governmental plans of
moratorium on application of certain
nondiscrimination rules (sec. 432 of the bill,
sec. 1505 of the Taxpayer Relief Act of 1997,
and secs. 401(a) and 401(k) of the Code)....... 63
3. Notice and consent period regarding
distributions (sec. 433 of the bill, sec.
417(a) of the Code, and sec. 205(c) of ERISA).. 64
4. Pension plan reporting simplification (sec. 434
of the bill)................................... 65
5. Missing participants (sec. 435 of the bill and
sec. 4050 of ERISA)............................ 66
6. Reduced PBGC premiums for small and new plans
(secs. 436 and 437 of the bill and sec. 4006 of
ERISA)......................................... 68
7. Authorization for PBGC to pay interest on
premium overpayment refunds (sec. 438 of the
bill and sec. 4007(b) of ERISA)................ 69
8. Rules for substantial owner benefits in
terminated plans (sec. 439 of the bill and
secs. 4021, 4022, 4043, and 4044 of ERISA)..... 70
9. Voluntary early retirement incentive and
employment retention plans maintained by local
educational agencies and other entities (sec.
440 of the bill, secs. 457(e)(11) and 457(f) of
the Code, sec. 3(2)(B) of ERISA, and sec.
4(l)(1) of the ADEA)........................... 71
10. Two-year extension of transition rule to
pension funding requirements (sec. 769(c) of
the Retirement Protection Act of 1994)......... 73
11. Acceleration of PBGC computation of benefits
attributable to recoveries from employers (sec.
441 of the bill and secs. 4022(c) and 4062(c)
of ERISA)...................................... 75
12. Multiemployer plan funding and solvency notices
(sec. 442 of the bill and sec. 101 of ERISA)... 77
13. No reduction in unemployment compensation as a
result of pension rollovers (sec. 443 of the
bill and sec. 3304(a)(15) of the Code)......... 79
14. Withholding on certain distributions from
governmental eligible deferred compensation
plans (sec. 444 of the bill and sec. 457 of the
Code).......................................... 80
15. Minimum cost requirement for excess asset
transfers (sec. 445 of the bill and sec. 420 of
the Code)...................................... 80
16. Social Security coverage under divided
retirement system for public employees in
Kentucky....................................... 83
D. Studies (secs. 451 and 452 of the bill)............. 84
E. Other Provisions.................................... 86
1. Additional IRA catch-up contributions for
certain individuals (sec. 461 of the bill and
sec. 408 of the Code).......................... 86
2. Distributions by an S corporation to an employee
stock ownership plan (sec. 462 of the bill and
sec. 4975 of the Code)......................... 87
3. Permit qualified transfers of excess pension
assets to retiree health accounts by
multiemployer plan (sec. 463 of the bill, sec.
420 of the Code and secs. 101, 403 and 408 of
ERISA)......................................... 89
F. Plan Amendments (sec. 471 of the bill).............. 90
Title V. Provisions Relating to Executives and Stock Options. 92
A. Repeal of Limitation on Issuance of Treasury
Guidance Regarding Nonqualified Deferred
Compensation (sec. 501 of the bill)................ 92
B. Taxation of Nonqualified Deferred Compensation (sec.
502 of the bill and new sec. 409A of the Code)..... 96
C. Denial of Deferral of Certain Stock Option and
Restricted Stock Gains (sec. 503 of the bill and
sec. 83 of the Code)............................... 103
D. Increase in Withholding from Supplemental Wage
Payments in Excess of $1 Million (sec. 504 of the
bill and sec. 13273 of the Revenue Reconciliation
Act of 1993)....................................... 105
E. Exclusion of Incentive Stock Options and Employee
Stock Purchase Plan Stock Options From Wages (sec.
511 of the bill and secs. 421(b), 423(c), 3121(a),
3231, and 3306(b) of the Code)..................... 106
F. Capital Gain Treatment on Sale of Stock Acquired
From Exercise of Statutory Stock Options To Comply
With Conflict of Interest Requirements (sec. 512 of
the bill and sec. 421 of the Code)................. 107
Title VI. Women's Pension Protection........................ 108
A Study of Spousal Consent for Distributions From
Defined Contribution Plans (sec. 601 of the bill).. 108
B. Division of Pension Benefits Upon Divorce (sec. 611
of the bill)....................................... 110
C. Protection of Rights of Former Spouses Under the
Railroad Retirement System (secs. 621 and 622 of
the Act and secs. 2 and 5 of the Railroad
Retirement Act of 1974)............................ 112
D. Modifications of Joint and Survivor Annuity
Requirements (sec. 631 of the bill and secs. 401
and 417 of the Code and sec. 205 of ERISA)......... 113
Title VII. Tax Court Pension and Compensation Modernization. 115
A. Judges of the Tax Court (secs. 701-707 and 713 of
the bill and secs. 7443, 7447, 7448, and 7472 of
the Code).......................................... 115
B. Special Trial Judges of the Tax Court (secs. 708-713
of the bill, and sec. 7448 and new secs. 7443A,
7443B, and 7443C of the Code)...................... 117
Title VIII. Other Provisions................................ 120
A. Temporary Exclusion for Education Benefits Provided
by Employers to Children of Employees (sec. 801 of
the bill and sec. 127 of the Code)................. 120
B. Exclusion From Gross Income for Amounts Paid Under
National Health Service Corps Loan Repayment
Program (sec. 802 of the bill and sec. 108 of the
Code).............................................. 121
C. Temporary Exclusion for Group Legal Services
Benefits (sec. 803 of the bill and secs. 120 and
501(c)(20) of the Code)............................ 122
D. Transfer of Funds from Black Lung Trust Fund to
Combined Benefit Fund (sec. 804 of the bill and
secs. 501(c)(21) and 9705 of the Code)............. 122
E. Extension of Provision Permitting Qualified
Transfers of Excess Pension Assets to Retiree
Health Accounts (sec. 420 of the Code, and secs.
101, 403 and 408 of ERISA)......................... 124
F. Application of Basis Rules to Nonresident Aliens
(sec. 811 of the bill and new sec. 72(w) of the
Code).............................................. 126
G. Modify Qualification Rules for Tax-Exempt Property
and Casualty Insurance Companies and Modify
Definition of Insurance Company for Property and
Casualty Insurance Company (secs. 501(c)(15) and
831(b) and (c) of the Code)........................ 130
H. Tax Treatment of Company-Owned Life Insurance
(``COLI'') (secs. 812 and 813 of the bill and new
secs. 101(j) and 6039I of the Code)................ 134
I. Reporting of Taxable Mergers and Acquisitions (sec.
813 of the bill and new sec. 6043A of the Code).... 139
III. Budget Effects of the Bill.................................. 140
IV. Votes of the Committee...................................... 145
V Regulatory Impact and Other Matters......................... 145
VI. Additional Views............................................ 148
VII. Changes in Existing Law Made by the Bill as Reported........ 153
I. LEGISLATIVE BACKGROUND
Overview
The Senate Committee on Finance marked up an original bill,
the ``National Employee Savings and Trust Equity Guarantee
Act,'' on September 17, 2003, and ordered the bill favorably
reported by voice vote. On October 1, 2003, the Finance
Committee by unanimous consent recalled the bill and amended it
to make the company-owned life insurance (``COLI'') provision
effective on date of enactment instead of date of committee
action and agreed to a further markup of the COLI and related
provisions of the bill. On February 2, 2004, the Committee
marked up a modification to the bill and ordered the bill
favorably reported by voice vote.
Recent legislation
The bill as approved by the Committee contained several
provisions that are identical or substantially similar to
provisions in recently enacted legislation and therefore are
not contained in the bill as reported.
The Pension Equity Funding Act of 2004\1\ contains
provisions relating to:
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\1\ Pub. L. No. 108-218 (April 10, 2004). The Pension Equity
Funding Act of 2004 also includes provisions relating to issues that
are addressed by provisions in the bill, including the interest rate
used for certain pension purposes and relief from the deficit reduction
contribution requirements.
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Two-year extension of transition rule to pension
funding requirements;
Extension of provision permitting qualified
transfers of excess pension assets to retiree health accounts;
Modification of qualification rules for tax-exempt
property and casualty insurance companies; and
Definition of insurance company for property and
casualty insurance company tax rules.
The Social Security Protection Act of 2004\2\ contains a
provision allowing Social Security coverage under a divided
retirement system for public employees in Kentucky.
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\2\ Pub. L. No. 108-203 (March 2, 2004).
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Hearings
During the 108th Congress, the Committee held hearings on
various topics relating to the provisions of the bill, as
follows.
The Committee held a hearing on April 8, 2003, on
compensation-related issues addressed in the Joint Committee on
Taxation staff investigation and report relating to Enron
Corporation. The Committee also held a hearing on March 11,
2003, on issues relating to the funding of defined benefit
plans.
The Committee held a hearing on COLI on October 23, 2003.
Activity during the 107th Congress
During the 107th Congress, the Committee reported a bill,
S. 1971 (the ``National Employee Savings and Trust Equity
Guarantee Act''), which addressed many of the same issues
addressed by the current bill. Many of the provisions in the
current bill are substantially the same as those previously
reported by the Committee in S. 1971 (107th Cong.)
During the 107th Congress, the Committee held hearings on
various topics relating to the provisions of S. 1971 (107th
Cong.). The Committee held a hearing on February 27, 2002,
regarding retirement security. The Committee also held a
hearing on April 18, 2002, regarding corporate governance and
executive compensation.
II. EXPLANATION OF THE BILL
TITLE I. DIVERSIFICATION OF PENSION PLAN ASSETS
A. Defined Contribution Plans Required To Provide Employees With
Freedom To Invest Their Plan Assets
(Sec. 101 of the bill, new sec. 401(a)(35) of the Code, and new sec.
204(j) of ERISA)
PRESENT LAW
In general
Defined contribution plans may permit both employees and
employers to make contributions to the plan. Under a qualified
cash or deferred arrangement (commonly referred to as a
``section 401(k) plan''), employees may elect to make pretax
contributions to a plan, referred to as elective deferrals.
Employees may also be permitted to make after-tax contributions
to a plan. In addition, a plan may provide for employer
nonelective contributions or matching contributions.
Nonelective contributions are employer contributions that are
made without regard to whether the employee makes elective
deferrals or after-tax contributions. Matching contributions
are employer contributions that are made only if the employee
makes elective deferrals or after-tax contributions.
Under the Internal Revenue Code (the ``Code''), \3\
elective deferrals, after-tax employee contributions, and
employer matching contributions are subject to special
nondiscrimination tests. Certain employer nonelective
contributions may be used to satisfy these special
nondiscrimination tests. In addition, plans may satisfy the
special nondiscrimination tests by meeting certain safe harbor
contribution requirements.
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\3\ All references to the ``Code'' are to the Internal Revenue
Code. All section references and descriptions of present law refer to
the Code unless otherwise indicated.
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The Code requires employee stock ownership plans
(``ESOPs'') to offer certain plan participants the right to
diversify investments in employer securities. The Employee
Retirement Income Security Act of 1974 (``ERISA'') limits the
amount of employer securities and employer real property that
can be acquired or held by certain employer-sponsored
retirement plans. The extent to which the ERISA limits apply
depends on the type of plan and the type of contribution
involved.
Diversification requirements applicable to ESOPs under the Code
An ESOP is a defined contribution plan that is designated
as an ESOP and is designed to invest primarily in qualifying
employer securities and that meets certain other requirements
under the Code. For purposes of ESOP investments, a
``qualifying employer security'' is defined as: (1) publicly
traded common stock of the employer or a member of the same
controlled group; (2) if there is no such publicly traded
common stock, common stock of the employer (or member of the
same controlled group) that has both voting power and dividend
rights at least as great as any other class of common stock; or
(3) noncallable preferred stock that is convertible into common
stock described in (1) or (2) and that meets certain
requirements. In some cases, an employer may design a class of
preferred stock that meets these requirements and that is held
only by the ESOP.
An ESOP can be an entire plan or it can be a component of a
larger defined contribution plan. An ESOP may provide for
different types of contributions. For example, an ESOP may
include a qualified cash or deferred arrangement that permits
employees to make elective deferrals.\4\
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\4\ Such an ESOP design is sometimes referred to as a ``KSOP.''
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Under the Code, ESOPs are subject to a requirement that a
participant who has attained age 55 and who has at least 10
years of participation in the plan must be permitted to
diversify the investment of the participant's account in assets
other than employer securities.\5\ The diversification
requirement applies to a participant for six years, starting
with the year in which the individual first meets the
eligibility requirements (i.e., age 55 and 10 years of
participation). The participant must be allowed to elect to
diversify up to 25 percent of the participant's account (50
percent in the sixth year), reduced by the portion of the
account diversified in prior years.
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\5\ Sec. 401(a)(28). The present-law diversification requirements
do not apply to employer securities held by an ESOP that were acquired
before January 1, 1987.
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The participant must be given 90 days after the end of each
plan year in the election period to make the election to
diversify. In the case of participants who elect to diversify,
the plan satisfies the diversification requirement if: (1) the
plan distributes the applicable amount to the participant
within 90 days after the election period; (2) the plan offers
at least three investment options (not inconsistent with
Treasury regulations) and, within 90 days of the election
period, invests the applicable amount in accordance with the
participant's election; or (3) the applicable amount is
transferred within 90 days of the election period to another
qualified defined contribution plan of the employer providing
investment options in accordance with (2).\6\
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\6\ IRS Notice 88-56, 1988-1 C.B. 540, Q&A-16.
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ERISA limits on investments in employer securities and real property
ERISA imposes restrictions on the investment of retirement
plan assets in employer securities or employer real
property.\7\ A retirement plan may hold only a ``qualifying''
employer security and only ``qualifying'' employer real
property.
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\7\ ERISA sec. 407.
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Under ERISA, any stock issued by the employer or an
affiliate of the employer is a qualifying employer security.\8\
Qualifying employer securities also include certain publicly
traded partnership interests and certain marketable obligations
(i.e., a bond, debenture, note, certificate or other evidence
of indebtedness). Qualifying employer real property means
parcels of employer real property: (1) if a substantial number
of the parcels are dispersed geographically; (2) if each parcel
of real property and the improvements thereon are suitable (or
adaptable without excessive cost) for more than one use; (3)
even if all of the real property is leased to one lessee (which
may be an employer, or an affiliate of an employer); and (4) if
the acquisition and retention of such property generally comply
with the fiduciary rules of ERISA (with certain specified
exceptions).
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\8\ Certain additional requirements apply to employer stock held by
a defined benefit pension plan or a money purchase pension plan (other
than certain plans in existence before the enactment of ERISA).
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ERISA also prohibits defined benefit pension plans and
money purchase pension plans (other than certain plans in
existence before the enactment of ERISA) from acquiring
employer securities or employer real property if, after the
acquisition, more than 10 percent of the assets of the plan
would be invested in employer securities and real property.
Except as discussed below with respect to elective deferrals,
this 10-percent limitation generally does not apply to defined
contribution plans other than money purchase pension plans.\9\
In addition, a fiduciary generally is deemed not to violate the
requirement that plan assets be diversified with respect to the
acquisition or holding of employer securities or employer real
property in a defined contribution plan.\10\
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\9\ The 10-percent limitation also applies to a defined
contribution plan that is part of an arrangement under which benefits
payable to a participant under a defined benefit pension plan are
reduced by benefits under the defined contribution plan (i.e., a
``floor-offset'' arrangement).
\10\ Under ERISA, a defined contribution plan is generally referred
to as an individual account plan. Plans that are not subject to the 10-
percent limitation on the acquisition of employer securities are
referred to as ``eligible individual account plans.''
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The 10-percent limitation on the acquisition of employer
securities and real property applies separately to the portion
of a plan consisting of elective deferrals (and earnings
thereon) if any portion of an individual's elective deferrals
(or earnings thereon) are required to be invested in employer
securities or real property pursuant to plan terms or the
direction of a person other than the participant. This
restriction does not apply if: (1) the amount of elective
deferrals required to be invested in employer securities and
real property does not exceed more than one percent of any
employee's compensation; (2) the fair market value of all
defined contribution plans maintained by the employer is no
more than 10 percent of the fair market value of all retirement
plans of the employer; or (3) the plan is an ESOP.
REASONS FOR CHANGE
Recent events have focused public attention on the
investment of retirement plan assets in employer securities.
The bankruptcies of several large publicly-traded companies,
such as the Enron Corporation, have been accompanied by the
loss of employees' pension benefits because defined
contribution plan assets were heavily invested in employer
securities. In many cases, employees lost not only their jobs,
but also their retirement savings, upsetting their plans for
retirement.
The Committee understands that employer securities are one
possible investment for defined contribution plans. In some
cases, the plan may offer employer securities as one of several
investment options made available to plan participants. In
other cases, the plan may provide that certain contributions
are invested in employer securities. For example, many plans
provide that employer matching contributions with respect to
employee elective deferrals under a qualified cash or deferred
arrangement are to be invested in employer securities.
Present law has facilitated and encouraged the acquisition
of employer securities by defined contribution plans,
particularly in the case of ESOPs. Thus, for example, present
law provides that the dividends paid on employer securities
held by an ESOP are deductible under certain circumstances and
also allows an ESOP to borrow to acquire the employer
securities. Present law recognizes that employer securities can
be a profitable investment for employees as well as a corporate
financing tool for employers. Employees who hold employer
securities through a defined contribution plan often feel that
they have a stake in the business, leading to increased
profitability.
On the other hand, the Committee recognizes that
diversification of assets is a basic principle of sound
investment policy and that requiring certain contributions to
be invested in employer securities may create tension with the
objectives of diversification. Failure to adequately diversify
defined contribution plan investments may jeopardize retirement
security. The Committee believes that participants should be
provided with a greater opportunity to diversify plan
investments in employer securities.
In addition, at the request of the Committee, the staff of
the Joint Committee on Taxation (``Joint Committee staff'')
undertook an investigation relating to Enron Corporation and
related entities, including a review of the compensation
arrangements of Enron employees, e.g., qualified retirement
plans, nonqualified deferred compensation arrangements, and
other arrangements. The Joint Committee staff issued an
official report of its investigation,\11\ including findings
and recommendations resulting from its review of Enron's
pension plans and compensation arrangements. The Joint
Committee staff's findings support the Committee's views
regarding the need for greater diversification in the
investment of defined contribution plan assets. The Joint
Committee staff found that participants in Enron's Savings Plan
lost considerable amounts of retirement savings due to the high
level of investment in Enron stock and that Enron's plan is not
alone in its high concentration of investment in employer
stock.\12\ The Joint Committee staff recommended legislative
changes to allow participants greater opportunities to invest
their accounts in diversified investments, rather than in
employer securities.\13\
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\11\ Joint Committee on Taxation, Report of Investigation of Enron
Corporation and Related Entities Regarding Federal Tax and Compensation
Issues, and Policy Recommendations (JCS-3-03), February 2003.
\12\ Id. at Vol. I. 12-13, 39-40, 515-540.
\13\ Id. at Vol. I, 19, 39-40, 538-540.
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The Committee believes that allowing participants greater
opportunity to diversify plan investments in employer
securities will help participants achieve their retirement
security goals, while continuing to allow employers and
employees the freedom to choose their own investments. The
Committee bill therefore requires certain defined contribution
plans that hold employer securities that are publicly traded to
permit plan participants to direct the plan to reinvest
employer securities in other assets. The Committee bill
generally requires diversification in accordance with the
present-law rules regarding vesting.
Recent issues relating to investments in employer
securities have arisen in the context of publicly-traded
companies. Although similar issues may arise with respect to
investments in employer securities by retirement plans of
privately-held companies, the Committee understands that such
investments often play a different role than in the case of
publicly-traded companies. For example, it is more common for
an ESOP of a privately-held company to hold a controlling
interest in the employer. In addition, because of the lack of a
public market for the securities, diversification could put an
undue financial strain on the employer. Thus, the
diversification requirements in the bill apply only to defined
contribution plans holding employer securities of publicly
traded companies.
The Committee believes that the current role of ESOPs
should be preserved in order to encourage this form of
ownership. Thus, the bill does not apply additional
diversification requirements to ``stand alone'' ESOPs, meaning
ESOPs that do not hold elective deferrals and related
contributions. Again, the Committee believes this strikes an
appropriate balance between the principle of diversification
and the goals served by ESOPs.
Investment of defined contribution plan assets in employer
real property may present similar issues as to adequate
diversification, particularly if plan assets are also invested
in employer securities. Accordingly, the diversification
requirements apply to both employer securities and employer
real property in the case of a plan that holds publicly-traded
employer securities.
EXPLANATION OF PROVISION
In general
Under the provision, in order to satisfy the plan
qualification requirements of the Code and the vesting
requirements of ERISA, certain defined contribution plans are
required to provide diversification rights with respect to
amounts invested in employer securities or employer real
property. Such a plan is required to permit applicable
individuals to direct that the portion of the individual's
account held in employer securities or employer real property
be invested in alternative investments. Under the provision, an
applicable individual includes: (1) any plan participant; and
(2) any beneficiary who has an account under the plan with
respect to which the beneficiary is entitled to exercise the
rights of a participant. The time when the diversification
requirements apply depends on the type of contributions
invested in employer securities or employer real property.
Plans subject to requirements
The diversification requirements generally apply to an
``applicable defined contribution plan,'' \14\ which means a
defined contribution plan holding publicly-traded employer
securities (i.e., securities issued by the employer or a member
of the employer's controlled group of corporations \15\ that
are readily tradable on an established securities market).
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\14\ Under ERISA, the diversification requirements apply to an
``applicable individual account plan.''
\15\ For this purpose, ``controlled group of corporations'' has the
same meaning as under section 1563(a), except that, in applying that
section, 50 percent is substituted for 80 percent.
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For this purpose, a plan holding employer securities that
are not publicly traded is generally treated as holding
publicly-traded employer securities if the employer (or any
member of the employer's controlled group of corporations) has
issued a class of stock that is a publicly-traded employer
security. This treatment does not apply if neither the employer
nor any parent corporation \16\ of the employer has issued any
publicly-traded security or any special class of stock that
grants particular rights to, or bears particular risks for, the
holder or the issuer with respect to any member of the
employer's controlled group that has issued any publicly-traded
employer security. For example, a controlled group that
generally consists of corporations that have not issued
publicly-traded securities, may include a member that has
issued publicly-traded stock (the ``publicly-traded member'').
In the case of a plan maintained by an employer that is another
member of the controlled group, the diversification
requirements do not apply to the plan, provided that neither
the employer nor a parent corporation of the employer has
issued any publicly-traded security or any special class of
stock that grants particular rights to, or bears particular
risks for, the holder or issuer with respect to the member that
has issued publicly-traded stock. The Secretary of the Treasury
has the authority to provide other exceptions in regulations.
For example, an exception may be appropriate if no stock of the
employer maintaining the plan (including stock held in the
plan) is publicly traded, but a member of the employer's
controlled group has issued a small amount of publicly-traded
stock.
---------------------------------------------------------------------------
\16\ For this purpose, ``parent corporation'' has the same meaning
as under section 424(e), i.e., any corporation (other than the
employer) in an unbroken chain of corporations ending with the employer
if each corporation other than the employer owns stock possessing at
least 50 percent of the total combined voting power of all classes of
stock with voting rights or at least 50 percent of the total value of
shares of all classes of stock in one of the other corporations in the
chain.
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The diversification requirements do not apply to an ESOP
that: (1) does not hold contributions (or earnings thereon)
that are subject to the special nondiscrimination tests that
apply to elective deferrals, employee after-tax contributions,
and matching contributions; and (2) is a separate plan from any
other qualified retirement plan of the employer. Accordingly,
an ESOP that holds elective deferrals, employee contributions,
employer matching contributions, or nonelective employer
contributions used to satisfy the special nondiscrimination
tests (including the safe harbor methods of satisfying the
tests) is subject to the diversification requirementsunder the
provision. The diversification rights applicable under the provision
are broader than those applicable under the Code's present-law ESOP
diversification rules. Thus, an ESOP that is subject to the new
requirements is excepted from the present-law rules.\17\
---------------------------------------------------------------------------
\17\ An ESOP will not be treated as failing to be designed to
invest primarily in qualifying employer securities merely because the
plan provides diversification rights as required under the provision or
greater diversification rights than required under the provision.
---------------------------------------------------------------------------
The diversification requirements under the provision also
do not apply to a one-participant retirement plan. A one-
participant retirement plan is a plan that: (1) on the first
day of the plan year, covers only one individual (or the
individual and his or her spouse) and the individual owns 100
percent of the plan sponsor (i.e., the employer maintaining the
plan), whether or not incorporated, or covered only one or more
partners (or partners and their spouses) in the plan sponsor;
(2) meets the minimum coverage requirements without being
combined with any other plan that covers employees of the
business; (3) does not provide benefits to anyone except the
individuals (and spouses) described in (1); (4) does not cover
a business that is a member of an affiliated service group, a
controlled group of corporations, or a group of corporations
under common control; and (5) does not cover a business that
uses leased employees. It is intended that, for this purpose, a
``partner'' includes an owner of a business that is treated as
a partnership for tax purposes. In addition, it includes a two-
percent shareholder of an S corporation.\18\
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\18\ Under section 1372, a two-percent shareholder of an S
corporation is treated as a partner for fringe benefit purposes.
---------------------------------------------------------------------------
Elective deferrals and after-tax employee contributions
In the case of amounts attributable to elective deferrals
under a qualified cash or deferred arrangement and employee
after-tax contributions that are invested in employer
securities or employer real property, any applicable individual
must be permitted to direct that such amounts be invested in
alternative investments.
Other contributions
In the case of amounts attributable to contributions other
than elective deferrals and after-tax employees contributions
(i.e., nonelective employer contributions and employer matching
contributions) that are invested in employer securities or
employer real property, an applicable individual who is a
participant with three years of service,\19\ a beneficiary of
such a participant, or a beneficiary of a deceased participant
must be permitted to direct that such amounts be invested in
alternative investments.
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\19\ Years of service is defined as under the rules relating to
vesting (sec. 411(a)).
---------------------------------------------------------------------------
The provision provides a transition rule for amounts
attributable to these other contributions that are invested in
employer securities or employer real property acquired before
the first plan year for which the new diversification
requirements apply. Under the transition rule, for the first
three years for which the new diversification requirements
apply to the plan, the applicable percentage of such amounts is
subject to diversification as shown in Table 1, below. The
applicable percentage applies separately to each class of
employer security and to employer real property in an
applicable individual's account. The transition rule does not
apply to plan participants who have three years of service and
who have attained age 55 by the beginning of the first plan
year beginning after December 31, 2003.
TABLE 1.--APPLICABLE PERCENTAGE FOR EMPLOYER SECURITIES OR EMPLOYER REAL
PROPERTY HELD ON EFFECTIVE DATE
------------------------------------------------------------------------
Applicable
Plan year for which diversification applies percentage
------------------------------------------------------------------------
First year................................................. 33
Second year................................................ 66
Third year................................................. 100
------------------------------------------------------------------------
The application of the transition rule is illustrated by
the following example. Suppose that the account of a
participant with at least three years of service held 120
shares of employer common stock contributed as matching
contributions before the diversification requirements became
effective. In the first year for which diversification applies,
33 percent (i.e., 40 shares) of that stock is subject to the
diversification requirements. In the second year for which
diversification applies, a total of 66 percent of 120 shares of
stock (i.e., 79 shares, or an additional 39 shares) is subject
to the diversification requirements. In the third year for
which diversification applies, 100 percent of the stock, or all
120 shares, is subject to the diversification requirements. In
addition, in each year, employer stock in the account
attributable to elective deferrals and employee after-tax
contributions is fully subject to the diversification
requirements, as is any new stock contributed to the account.
Rules relating to the election of investment alternatives
A plan subject to the diversification requirements is
required to give applicable individuals a choice of at least
three investment options, other than employer securities or
employer real property, each of which is diversified and has
materially different risk and return characteristics. It is
intended that other investment options generally offered by the
plan also must be available to applicable individuals.
A plan does not fail to meet the diversification
requirements merely because the plan limits the times when
divestment and reinvestment can be made to periodic, reasonable
opportunities that occur at least quarterly. It is intended
that applicable individuals generally be given the opportunity
to make investment changes with respect to employer securities
or employer real property on the same basis as the opportunity
to make other investment changes, except in unusual
circumstances. Thus, in general, applicable individuals must be
given the opportunity to request changes with respect to
investments in employer securities or employer real property
with the same frequency as the opportunity to make other
investment changes and that such changes are implemented in the
same timeframe as other investment changes, unless
circumstances require different treatment. For example, in the
case of a plan that provides diversification rights with
respect to investments in employer real property, if the
property mustbe sold in order to implement an applicable
individual's request to divest his or her account of employer real
property, a longer period may be needed to implement the individual's
request than the time needed to implement other investment changes.
Providing a longer period is permissible in those circumstances.
Except as provided in regulations, a plan may not impose
restrictions or conditions with respect to the investment of
employer securities or employer real property that are not
imposed on the investment of other plan assets (other than
restrictions or conditions imposed by reason of the application
of securities laws). For example, such a restriction or
condition includes a provision under which a participant who
divests his or her account of employer securities or employer
real property receives less favorable treatment (such as a
lower rate of employer contributions) than a participant whose
account remains invested in employer securities or employer
real property. On the other hand, such a restriction does not
include the imposition of fees with respect to other investment
options under the plan, merely because fees are not imposed
with respect to investments in employer securities.
EFFECTIVE DATE
The provision is generally effective for plan years
beginning after December 31, 2003. In the case of a plan
maintained pursuant to one or more collective bargaining
agreements, the provision is effective for plan years beginning
after the earlier of (1) the later of December 31, 2004, or the
date on which the last of such collective bargaining agreements
terminates (determined without regard to any extension thereof
after the date of enactment), or (2) December 31, 2005.
A special effective date applies with respect to employer
matching and nonelective contributions (and earnings thereon)
that are invested in employer securities that, as of September
17, 2003: (1) consist of preferred stock; and (2) are held
within an ESOP, under the terms of which the value of the
preferred stock is subject to a guaranteed minimum. Under the
special rule, the diversification requirements apply to such
preferred stock for plan years beginning after the earlier of
(1) December 31, 2006; or (2) the first date as of which the
actual value of the preferred stock equals or exceeds the
guaranteed minimum. When the new diversification requirements
become effective for the plan under the special rule, the
applicable percentage of employer securities or employer real
property held on the effective date that is subject to
diversification is determined without regard to the special
rule. For example, if, under the general effective date, the
diversification requirements would first apply to the plan for
the first plan year beginning after December 31, 2003, and,
under the special rule, the diversification requirements first
apply to the plan for the first plan year beginning after
December 31, 2006, the applicable percentage for that year is
100 percent.
B. Notice of Freedom to Divest Employer Securities or Real Property
(Sec. 102 of the bill, new sec. 4980H of the Code, and new sec. 104(d)
of ERISA)
PRESENT LAW
Under ERISA, a plan administrator is required to furnish
participants with certain notices and information about the
plan. This information includes, for example, a summary plan
description that includes certain information, including
administrative information about the plan, the plan's
requirements as to eligibility for participation and benefits,
the plan's vesting provisions, and the procedures for claiming
benefits under the plan. Under ERISA, if a plan administrator
fails or refuses to furnish to a participant information
required to be provided to the participant within 30 days of
the participant's written request, the participant generally
may bring a civil action to recover from the plan administrator
$100 a day, within the court's discretion, or other relief that
the court deems proper.
The Code contains a variety of notice requirements with
respect to qualified plans. Such requirements are generally
enforced by an excise tax. For example, in case of a failure to
provide notice of a significant reduction in benefit accruals,
an excise tax of $100 a day is generally imposed on the
employer. If the employer exercised reasonable diligence in
meeting the requirements, the excise tax with respect to a
taxable year is limited to no more than $500,000.
REASONS FOR CHANGE
The bill provides participants with new rights to diversify
the investment of their defined contribution plan accounts.
After the new diversification requirements become effective,
information about these rights will be provided to participants
in accordance with present law, for example, as part of the
summary plan description. However, under present law, such
information is not required to be provided at the time the new
diversification requirements become effective. Moreover, with
respect to future participants, such information may be
provided when an employee first becomes a participant in the
plan, generally after one year of service, whereas, in some
cases, a participant becomes eligible for diversification after
three years of service. The Committee believes that
participants should receive a specific notice of their
diversification rights shortly before they first become
eligible to exercise such rights. Such notice will better
enable participants to exercise and benefit from the new
diversification rights.
EXPLANATION OF PROVISION
In general
The provision requires a new notice under the Code and
ERISA in connection with the right of an applicable individual
to divest his or her account under an applicable defined
contribution plan of employer securities or employer real
property, as required under the diversification provision of
the bill. Not later than 30 days before the first date on which
an applicable individual is eligible to exercise such right
with respect to any type of contribution, the administrator of
the plan must provide the individual with a notice setting
forth such rightand describing the importance of diversifying
the investment of retirement account assets. Under the diversification
provision of the bill, an applicable individual's right to divest his
or her account of employer securities or employer real property
attributable to elective deferrals and employee after-tax contributions
and the right to divest his or her account of employer securities or
employer real property attributable to other contributions (i.e.,
nonelective employer contributions and employer matching contributions)
may become exercisable at different times. Thus, to the extent the
applicable individual is first eligible to exercise such rights at
different times, separate notices are required.
The notice must be written in a manner calculated to be
understood by the average plan participant and may be delivered
in written, electronic, or other appropriate form to the extent
that such form is reasonably accessible to the applicable
individual. The Secretary of Labor is directed to prescribe a
model notice to be used for this purpose within 180 days of
enactment of the provision.
Sanctions for failure to provide notice
Excise tax
Under the provision, an excise tax generally applies in the
case of a failure to provide notice of diversification rights
as required under the Code. The excise tax is generally imposed
on the employer if notice is not provided.\20\ The excise tax
is $100 per day for each participant or beneficiary with
respect to whom the failure occurs, until notice is provided or
the failure is otherwise corrected. If the employer exercises
reasonable diligence to meet the notice requirement, the total
excise tax imposed during a taxable year will not exceed
$500,000.
---------------------------------------------------------------------------
\20\ In the case of a multiemployer plan, the excise tax is imposed
on the plan.
---------------------------------------------------------------------------
No tax will be imposed with respect to a failure if the
employer does not know that the failure existed and exercises
reasonable diligence to comply with the notice requirement. In
addition, no tax will be imposed if the employer exercises
reasonable diligence to comply and provides the required notice
within 30 days of learning of the failure. In the case of a
failure due to reasonable cause and not to willful neglect, the
Secretary of the Treasury is authorized to waive the excise tax
to the extent that the payment of the tax would be excessive or
otherwise inequitable relative to the failure involved.
ERISA civil penalty
In the case of a failure to provide notice of
diversification rights as required under ERISA, the Secretary
of Labor may assess a civil penalty against the plan
administrator of up to $100 a day from the date of the failure.
For this purpose, each violation with respect to any single
applicable individual is treated as a separate violation.
EFFECTIVE DATE
The provision generally applies on the date of enactment of
the provision. Under a transition rule, if notice under the
provision would otherwise be required before 90 days after the
date of enactment, notice is not required until 90 days after
the date of enactment.
TITLE II. INFORMATION TO ASSIST PENSION PLAN PARTICIPANTS
A. Periodic Pension Benefit Statements and Investment Education
(Secs. 201-202 of the bill, new sec. 4980I of the Code, and sec. 104
and 105(a) of ERISA)
PRESENT LAW
In general
Under ERISA, a plan administrator is required to furnish
participants with certain notices and information about the
plan.\21\ If a plan administrator fails or refuses to furnish
to a participant information required to be provided to the
participant within 30 days of the participant's written
request, the participant generally may bring a civil action to
recover from the plan administrator $100 a day, within the
court's discretion, or other relief that the court deems
proper.
---------------------------------------------------------------------------
\21\ Governmental plans and church plans are exempt from ERISA,
including requirements to provide notices or information to
participants.
---------------------------------------------------------------------------
The Code contains a variety of notice requirements with
respect to qualified plans. Such requirements are generally
enforced by an excise tax. For example, in case of a failure to
provide notice of a significant reduction in benefit accruals,
an excise tax of $100 a day is generally imposed on the
employer. If the employer exercised reasonable diligence in
meeting the requirements, the excise tax with respect to a
taxable year is limited to no more than $500,000.
Pension benefit statements
ERISA provides that a plan administrator must furnish a
benefit statement to any participant or beneficiary who makes a
written request for such a statement. The benefit statement
must indicate, on the basis of the latest available
information: (1) the participant's or beneficiary's total
accrued benefit; and (2) the participant's or beneficiary's
vested accrued benefit or the earliest date on which the
accrued benefit will become vested. A participant or
beneficiary is not entitled to receive more than one benefit
statement during any 12-month period.
Statements to participants on separation from service
A plan administrator must furnish a statement to each
participant who: (1) separates from service during the year;
(2) is entitled to a deferred vested benefit under the plan as
of the end of the plan year; and (3) whose benefits were not
paid during the year. The statement must set forth the nature,
amount, and form of the deferred vested benefit to which the
participant is entitled. The plan administrator generally must
provide the statement no later than 180 days after the end of
the plan year in which the separation from service occurs.
Investment guidelines
Present law does not require that participants be given
investment guidelines relating to retirement savings.
REASONS FOR CHANGE
The Committee believes that regular information concerning
the value of retirement benefits, especially the value of
benefits accumulating in a defined contribution plan account,
is necessary to increase employee awareness and appreciation of
the importance of retirement savings.
Under some employer-sponsored retirement plans,
participants are responsible for directing the investment of
the assets in their accounts under the plan. Awareness of
investment principles, including the need for diversification,
is fundamental to making investment decisions consistent with
long-term retirement income security. The Committee believes
participants should be provided with investment guidelines and
information for calculating retirement income to enable them to
make sound investment and retirement savings decisions.
At the request of the Committee, the Joint Committee staff
undertook an investigation relating to Enron Corporation and
related entities, including a review of the compensation
arrangements of Enron employees, e.g., qualified retirement
plans, nonqualified deferred compensation arrangements, and
other arrangements. The Joint Committee staff issued an
official report of its investigation,\22\ including findings
and recommendations resulting from its review of Enron's
pension plans and compensation arrangements. The Joint
Committee staff's findings support the Committee's views
regarding participants' need for investment education. The
Joint Committee staff found that significant amounts of plan
assets were invested in Enron stock even though the plan
offered approximately 20 other investment options.\23\ The
Joint Committee staff recommended legislative changes to
require plans to provide participants with notices regarding
investment principles and investment education.\24\
---------------------------------------------------------------------------
\22\ Joint Committee on Taxation, Report of Investigation of Enron
Corporation and Related Entities Regarding Federal Tax and Compensation
Issues, and Policy Recommendations (JCS-3-03), February 2003.
\23\ Id. at Vol. I, 12, 522-523, 526-535, 536.
\24\ Id. at Vol. I, 19, 39, 538.
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EXPLANATION OF PROVISION
Pension benefit statements
In general
The provision provides new benefit statement requirements
under the Code and ERISA, depending in part on the type of plan
and the individual to whom the statement is provided. The
benefit statement requirements do not apply to a one-
participant retirement plan.\25\
---------------------------------------------------------------------------
\25\ The term ``one-participant retirement plan'' is defined as
under the provision requiring plans to provide diversification rights
with respect to employer securities and employer real property.
---------------------------------------------------------------------------
Requirements for defined contribution plans
Under the provision, the administrator of a defined
contribution plan is required under the Code and ERISA to
provide a benefit statement (1) to a participant or beneficiary
who has the right to direct the investment of the assets in his
or her account, at least quarterly, (2) to any other
participant or other beneficiary who has his or her own account
under the plan, at least annually, and (3) to other
beneficiaries, upon written request, but limited to one request
during any 12-month period.\26\
---------------------------------------------------------------------------
\26\ In the case of a tax-sheltered annuity (sec. 403(b)) that is
not a plan established or maintained by the employer, the benefit
statement generally must be provided by the issuer of the annuity
contract.
---------------------------------------------------------------------------
The benefit statement is required to indicate, on the basis
of the latest available information: (1) the total benefits
accrued; (2) the vested accrued benefit or the earliest date on
which the accrued benefit will become vested; and (3) an
explanation of any offset that may be applied in determining
accrued benefits under a plan that provides for permitted
disparity or that is part of a floor-offset arrangement (i.e.,
an arrangement under which benefits payable to a participant
under a defined benefit pension plan are reduced by benefits
under a defined contribution plan). With respect to information
on vested benefits, the Secretary of Labor is required to
provide that the requirements of the provision are met if, at
least annually, the plan: (1) updates the information on vested
benefits that is provided in the benefit statement; or (2)
provides in a separate statement information as is necessary to
enable participants and beneficiaries to determine their vested
benefits.
The benefit statement must also include the value of each
investment to which assets in the individual's account are
allocated (determined as of the plan's most recent valuation
date), including the value of any assets held in the form or
employer securities or employer real property (without regard
to whether the securities or real property were contributed by
the employer or acquired at the direction of the individual). A
quarterly benefit statement provided to a participant or
beneficiary who has the right to direct investments must also
provide: (1) an explanation of any limitations or restrictions
on any right of the individual to direct an investment; and (2)
a notice that investments in any individual account may not be
adequately diversified if the value of any investment in the
account exceeds 20 percent of the fair market value of all
investments in the account.
Requirements for defined benefit pension plans
Under the provision, the administrator of a defined benefit
pension plan is required under the Code and ERISA either: (1)
to furnish a benefit statement at least once every three years
to each participant who has a vested accrued benefit and who is
employed by the employer at the time the benefit statements are
furnished to participants; or (2) to furnish at least annually
to each such participant notice of the availability of a
benefit statement and the manner in which the participant can
obtain it. The Secretary of Labor is authorized to provide that
years in which no employee or former employee benefits under
the plan need not be taken into account in determining the
three-year period. It is intended that the annual notice of the
availability of a benefit statement may be included with other
communications to the participant if done in a manner
reasonably designed to attract the attention of the
participant.
The administrator of a defined benefit pension plan is also
required to furnish a benefit statement to a participant or
beneficiary upon written request, limited to one request during
any 12-month period.
The benefit statement is required to indicate, on the basis
of the latest available information: (1) the total benefits
accrued; (2) the vested accrued benefit or the earliest date on
which the accrued benefit will become vested; and (3) an
explanation of any offset that may be applied in determining
accrued benefits under a plan that provides for permitted
disparity or that is part of a floor-offset arrangement (i.e.,
an arrangement under which benefits payable to a participant
under a defined benefit pension plan are reduced by benefits
under a defined contribution plan). With respect to information
on vested benefits, the Secretary of Labor is required to
provide that the requirements of the provision are met if, at
least annually, the plan: (1) updates the information on vested
benefits that is provided in the benefit statement; or provides
in a separate statement information as is necessary to enable
participants and beneficiaries to determine their vested
benefits. In the case of a statement provided to a participant
(other than at the participant's request), information may be
based on reasonable estimates determined under regulations
prescribed by the Secretary of Labor in consultation with the
Pension Benefit Guaranty Corporation.
Form of benefit statement
The benefit statement must be written in a manner
calculated to be understood by the average plan participant. It
may be delivered in written, electronic, or other appropriate
form to the extent that such form is reasonably accessible to
the recipient. For example, regulations could permit current
benefit statements to be provided on a continuous basis through
a secure plan website for a participant or beneficiary who has
access to the website.
The Secretary of Labor is directed, within 180 days after
the date of enactment of the provision, to develop one or more
model benefit statements, written in a manner calculated to be
understood by the average plan participant, that may be used by
plan administrators in complying with the requirements of ERISA
and the Code. The use of the model statement isoptional. It is
intended that the model statement include items such as the amount of
nonforfeitable accrued benefits as of the statement date that are
payable at normal retirement age under the plan, the amount of accrued
benefits that are forfeitable but that may become nonforfeitable under
the terms of the plan, information on how to contact the Social
Security Administration to obtain a participant's personal earnings and
benefit estimate statement, and other information that may be important
to understanding benefits earned under the plan.
Investment guidelines
In general
Under the provision, the administrator of a defined
contribution plan (other than a one-participant retirement
plan) is required under the Code and ERISA to provide at least
once a year a model form relating to basic investment
guidelines to each participant or beneficiary who has the right
to direct the investment of the assets in his or her account
under the plan.\27\
---------------------------------------------------------------------------
\27\ In the case of a tax-sheltered annuity (sec. 403(b)) that is
not a plan established or maintained by the employer, the model form
generally must be provided by the issuer of the annuity contract.
---------------------------------------------------------------------------
Model form
Under the provision, the Secretary of the Treasury is
directed, in consultation with the Secretary of Labor, to
develop and make available a model form containing basic
guidelines for investing for retirement. The guidelines in the
model form are to include: (1) information on the benefits of
diversification of investments; (2) information on the
essential differences, in terms of risk and return, of pension
plan investments, including stocks, bonds, mutual funds and
money market investments; (3) information on how an
individual's investment allocations under the plan may differ
depending on the individual's age and years to retirement, as
well as other factors determined by the Secretary; (4) sources
of information where individuals may learn more about pension
rights, individual investing, and investment advice; and (5)
such other information related to individual investing as the
Secretary determines appropriate. For example, information on
how investment fees may affect the return on an investment is
appropriate other information that the Secretary may determine
must be included in the investment guidelines.
The model form must also include addresses for Internet
sites, and a worksheet, that a participant or beneficiary may
use to calculate: (1) the retirement age value of the
individual's vested benefits under the plan (expressed as an
annuity amount and determined by reference to varied historical
annual rates of return and annuity interest rates); and (2)
other important amounts relating to retirement savings,
including the amount that an individual must save annually in
order to provide a retirement income equal to various
percentages of his or her current salary (adjusted for expected
growth prior to retirement). The Secretary of the Treasury is
directed to provide at least 90 days for public comment before
publishing final notice of the model form and to update the
model form at least annually. In addition, the Secretary of
Labor is required to develop an Internet site to be used by an
individual in making these calculations, the address of which
will be included in the model form.
The model form must be written in a manner calculated to be
understood by the average plan participant and may be delivered
in written, electronic, or other appropriate form to the extent
that such form is reasonably accessible to the recipient.
Sanctions for failure to provide information
Excise tax
Under the provision, an excise tax generally applies in the
case of a failure to provide a benefit statement or an
investment guideline model form as required under the Code. The
excise tax is generally imposed on the employer if a required
benefit statement or model form is not provided.\28\ The excise
tax is $100 per day for each participant or beneficiary with
respect to whom the failure occurs, until the benefit statement
or model form is provided or the failure is otherwise
corrected. If the employer exercises reasonable diligence to
meet the benefit statement or model form requirement, the total
excise tax imposed during a taxable year will not exceed
$500,000. The $500,000 annual limit applies separately to
failures to provide required benefit statements and failures to
provide the model form.
---------------------------------------------------------------------------
\28\ In the case of a multiemployer plan, the excise tax is imposed
on the plan. In the case of a tax-sheltered annuity (sec. 403(b)) that
is not a plan established or maintained by the employer, the tax is
generally imposed on the issuer of the annuity contract.
---------------------------------------------------------------------------
No tax will be imposed with respect to a failure if the
employer does not know that the failure existed and exercises
reasonable diligence to comply with the benefit statement or
model form requirement. In addition, no tax will be imposed if
the employer exercises reasonable diligence to comply and
provides the required benefit statement or model form within 30
days of learning of the failure. In the case of a failure due
to reasonable cause and not to willful neglect, the Secretary
of the Treasury is authorized to waive the excise tax to the
extent that the payment of the tax would be excessive or
otherwise inequitable relative to the failure involved.
ERISA enforcement
The ERISA remedies that apply in the case of a failure or
refusal to provide a participant with information under present
law apply if the plan administrator fails to furnish a benefit
statement required under the provision. That is, the
participant or beneficiary is entitled to bring a civil action
to recover from the plan administrator $100 a day, within the
court's discretion, or such other relief that the court deems
proper.
In the case of a failure to provide a model form relating
to basic investment guidelines required under the provision,
the Secretary of Labor may assess a civil penalty against the
plan administrator of up to $100 a day from the date of the
failure. For this purpose, each violation with respect to any
single participant or beneficiary is treated as a separate
violation.
Exception for governmental and church plans
The provision contains an exception from the benefit
statement and investment notice requirements under the Code for
a governmental plan or a church plan. In addition, such plans
are generally exempt from ERISA. Accordingly, the benefit
statement and investment notice requirements do not apply to a
governmental plan or a church plan.
EFFECTIVE DATE
The provision is generally effective for plan years
beginning after December 31, 2004. In the case of a plan
maintained pursuant to one or more collective bargaining
agreements, the provision is effective for plan years beginning
after the earlier of (1) the later of December 31, 2005, or the
date on which the last of such collective bargaining agreements
terminates (determined without regard to any extension thereof
after the date of enactment), or (2) December 31, 2006.
B. Material Information Relating to Investment in Employer Securities
(Sec. 203 of the bill, new sec. 4980H of the Code, and secs. 104 and
502 of ERISA)
PRESENT LAW
The Code and ERISA require that certain information be
provided to participants and beneficiaries under employer-
sponsored retirement plans. Present law does not specifically
require that participants in defined contribution plans which
permit participants to direct the investment of the assets in
their accounts in employer securities be provided with the
reports, statements, and communications which are required to
be provided to investors in connection with investing in
securities under applicable securities laws.
The Code contains a variety of notice requirements with
respect to qualified plans. Such requirements are generally
enforced by an excise tax. For example, in case of a failure to
provide notice of a significant reduction in benefit accruals,
an excise tax of $100 a day is generally imposed on the
employer. If the employer exercised reasonable diligence in
meeting the requirements, the excise tax with respect to a
taxable year is limited to no more than $500,000.
Under ERISA, if a plan administrator fails or refuses to
furnish to a participant information required to be provided to
the participant within 30 days of the participant's written
request, the participant generally may bring a civil action to
recover from the plan administrator $100 a day, within the
court's discretion, or other relief that the court deems
proper.
REASONS FOR CHANGE
The Committee believes that, in the case of a defined
contribution plan that allows participants and beneficiaries to
exercise control over the assets in their individual accounts,
the same material investment information that the plan sponsor
is required to disclose to investors under securities laws
should be provided to participants and beneficiaries whose
accounts are invested in employer stock. The Committee believes
that plan administrators should be required to provide this
information.
EXPLANATION OF PROVISION
In general
The provision creates a new requirement in connection with
defined contribution plans which permit participants to direct
the investment of the assets in their accounts in employer
securities. The provision amends the Code and ERISA to require
administrators of such plans to provide participants with all
reports, proxy statements, and other communications regarding
investment of such assets in employer securities to the extent
that such reports, statements, and communications are required
to be provided by the plan sponsor to investors in connection
with investment employer securities under applicable securities
laws. Any such information which is maintained by the plan
sponsor must be provided to the plan administrator.
The reports, statements, and communications may be
delivered in written, electronic, or other appropriate form to
the extent that such form is reasonably accessible to
participants.
Sanctions for failure to provide information
Excise tax
Under the provision, an excise tax generally applies in the
case of a failure to provide the information as required under
the Code. The excise tax is generally imposed on the employer
if notice is not provided.\29\ The excise tax is $100 per day
for each participant or beneficiary with respect to whom the
failure occurs, until the information is provided or the
failure is otherwise corrected. If the employer exercises
reasonable diligence to meet the requirement, the total excise
tax imposed during a taxable year will not exceed $500,000.
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\29\ In the case of a multiemployer plan, the excise tax is imposed
on the plan.
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No tax will be imposed with respect to a failure if the
employer does not know that the failure existed and exercises
reasonable diligence to comply with the requirement. In
addition, no tax is imposed if the employer exercises
reasonable diligence to comply and provides the required
information within 30 days of learning of the failure. In the
case of a failure due to reasonable cause and not to willful
neglect, the Secretary of the Treasury is authorized to waive
the excise tax to the extent that the payment of the tax would
be excessive or otherwise inequitable relative to the failure
involved.
ERISA civil penalty
In the case of a failure or refusal to provide the
information as required under the provision, the Secretary of
Labor may assess a civil penalty against the plan administrator
of up to $1,000 a day from the date of the failure or refusal
until it is corrected.
Effective Date
The provision is generally effective for plan years
beginning after December 31, 2003. In the case of a plan
maintained pursuant to one or more collective bargaining
agreements, the proposal is effective for plan years beginning
after the earlier of (1) the later of December 31, 2004, or the
date on which the last of such collective bargaining agreements
terminates (determined without regard to any extension thereof
after the date of enactment), or (2) December 31, 2005.
C. Fiduciary Rules for Plan Sponsors Designating Independent Investment
Advisors
(Sec. 204 of the bill and new sec. 404(e) of ERISA)
PRESENT LAW
ERISA requires an employee benefit plan to provide for one
or more named fiduciaries who jointly or severally have the
authority to control and manage the operation and
administration of the plan. In addition to fiduciaries named in
the plan, or identified pursuant to a procedure specified in
the plan, a person is a plan fiduciary under ERISA to the
extent the fiduciary exercises any discretionary authority or
control over management of the plan or exercises authority or
control over management or disposition of its assets, renders
investment advice for a fee or other compensation, or has any
discretionary authority or responsibility in the administration
of the plan. In certain circumstances, a fiduciary under ERISA
may be liable for a breach of responsibility by a co-fiduciary.
REASONS FOR CHANGE
The Committee believes that providing specific rules under
which a fiduciary may arrange for independent investment advice
to be provided to participants who are responsible for
directing the investment of their retirement assets will
facilitate the provision of such investment advice without
undercutting the fiduciary requirements of ERISA. The provision
of independent investment advice will better enable
participants to make sound investment decisions.
EXPLANATION OF PROVISION
In general
The provision amends ERISA by adding specific rules dealing
with the provision of investment advice to plan participants by
a qualified investment adviser. The provision applies to an
individual account plan \30\ that permits a participant or
beneficiary to direct the investment of the assets in his or
her account. Under the provision, if certain requirements are
met, an employer or other plan fiduciary will not be liable for
investment advice provided by a qualified investment adviser.
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\30\ An ``individual account plan'' is the term generally used
under ERISA for a defined contribution plan.
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Qualified investment adviser
Under the provision, a ``qualified investment adviser'' is
defined as a person who is a plan fiduciary by reason of
providing investment advice and who is also (1) a registered
investment adviser under the Investment Advisers Act of 1940 or
registered as an investment adviser under the laws of the State
(consistent with section 203A of the Investment Advisers Act
\31\) in which the adviser maintains its principal office, (2)
a bank or similar financial institution, (3) an insurance
company qualified to do business under State law, or (4) a
comparably qualified entity under criteria to be established by
the Secretary of Labor. In addition, any individual who
provides investment advice to participants on behalf of the
investment adviser (such as an employee thereof) is required to
be (1) a registered investment adviser under Federal or State
law as described above,\32\ (2) a registered broker or dealer
under the Securities Exchange Act, (3) a registered
representative under the Securities Exchange Act or the
Investment Advisers Act, or (4) any comparably qualified
individual under criteria to be established by the Secretary of
Labor.
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\31\ See, 15 U.S.C. 80b-3a. Nothing in the provision is intended to
restrict the authority under present law of any State to assert
jurisdiction over investment advisers and investment adviser
representatives based on their presence in the State or the fact that
they have clients in the State.
\32\ An individual who is registered as an investment adviser under
the laws of a State is a qualified investment adviser only if the State
has an examination requirement to qualify for such registration.
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A qualified investment adviser is required to provide the
following documents to the employer or plan fiduciary: (1) the
contract for investment advice services, (2) a disclosure of
any fees or other compensation to be received by the investment
adviser for the provision of investment advice and any fees or
other compensation to be received as a result of a
participant's investment choices, and (3) its registration with
the Securities and Exchange Commission or other documentation
of its status as a qualified investment adviser. A qualified
investment adviser that acknowledges its fiduciary status will
be a fiduciary under ERISA with respect to investment advice
provided to a participant or beneficiary.
Requirements for employer or other fiduciary
Before designating the investment adviser and at least
annually thereafter, the employer or other fiduciary is
required to obtain written verification that the investment
adviser (1) is a qualified investment adviser, (2) acknowledges
its status as a plan fiduciary that is solely responsible for
the investment advice it provides, (3) has reviewed the plan
document (including investment options) and determined that its
relationship with the plan and the investment advice provided
to any participant or beneficiary, including the receipt of
fees or compensation, will not violate the prohibited
transaction rules, (4) will consider any employer securities or
employer real property allocated to the participant's or
beneficiary's account in providing investment advice, and (5)
has the necessary insurance coverage (as determined by the
Secretary of Labor) for any claim by a participant or
beneficiary.
In designating an investment adviser, the employer or other
fiduciary is required to review the documents provided by the
qualified investment adviser. The employer or other fiduciary
is also required to make a determination that there is no
material reason not to engage the investment adviser.
In the case of (1) information that the investment adviser
is no longer qualified or (2) concerns about the investment
adviser's services raised by a substantial number of
participants or beneficiaries, the employer or other fiduciary
is required within 30 days to investigate and to determine
whether to continue the investment adviser's services.
An employer or other fiduciary that complies with the
requirements for designating and monitoring an investment
adviser will be deemed to have satisfied its fiduciary duty in
the prudent selection and periodic review of an investment
adviser and does not bear liability as a fiduciary or co-
fiduciary for any loss or breach resulting from the investment
advice.
EFFECTIVE DATE
The provision applies to investment advisers designated
after the date of enactment of the provision.
D. Employer-Provided Qualified Retirement Planning Services
(Sec. 205 of the bill and sec. 132 of the Code)
PRESENT LAW
Under present law, certain employer-provided fringe
benefits are excludable from gross income and wages for
employment tax purposes.\33\ These excludable fringe benefits
include qualified retirement planning services provided to an
employee and his or her spouse by an employer maintaining a
qualified employer plan. A qualified employer plan includes a
qualified retirement plan or annuity, a tax-sheltered annuity,
a simplified employee pension, a SIMPLE retirement account, or
a governmental plan, including an eligible deferred
compensation plan maintained by a governmental employer.
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\33\ Secs. 132 and 3121(a)(20).
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Qualified retirement planning services are retirement
planning advice and information. The exclusion is not limited
to information regarding the qualified employer plan, and,
thus, for example, applies to advice and information regarding
retirement income planning for an individual and his or her
spouse and how the employer's plan fits into the individual's
overall retirement income plan. On the other hand, the
exclusion does not apply to services that may be related to
retirement planning, such as tax preparation, accounting, legal
or brokerage services.
The exclusion does not apply with respect to highly
compensated employees unless the services are available on
substantially the same terms to each member of the group of
employees normally provided education and information regarding
the employer's qualified plan.
REASONS FOR CHANGE
The Committee believes that it is important for all
employees to have access to retirement planning advice and
information. In order to plan adequately for retirement,
individuals must anticipate retirement income needs and
understand how their retirement income goals can be achieved.
The Committee believes that allowing employees to purchase
qualified retirement planning services on a salary-reduction
basis will help many more employees obtain advice and
assistance when making retirement decisions.
EXPLANATION OF PROVISION
The provision permits employers to offer employees a choice
between cash compensation and eligible qualified retirement
planning services. The maximum amount for which such a choice
can be provided is limited to $1,000 per individual, per year.
The provision only applies to qualified retirement planning
services provided by an eligible investment adviser.
Under the provision, an ``eligible investment adviser'' is
defined as a person who is (1) a registered investment adviser
under the Investment Advisers Act of 1940 or registered as an
investment adviser under the laws of the State (consistent with
section 203A of the Investment Advisers Act \34\) in which the
adviser maintains its principal office, (2) a bank or similar
financial institution, (3) an insurance company qualified to do
business under State law, or (4) a comparably qualified entity
under criteria to be established by the Secretary of the
Treasury. In addition, any individual who provides investment
advice to participants on behalf of the investment adviser
(such as an employee thereof) is required to be (1) a
registered investment adviser under Federal or State law as
described above,\35\ (2) a registered broker or dealer under
the Securities Exchange Act, (3) a registered representative
under the Securities Exchange Act or the Investment Advisers
Act, or (4) any comparably qualified individual under criteria
to be established by the Secretary of the Treasury.
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\34\ See, 15 U.S.C. 80b-3a.
\35\ An individual who is registered as an investment adviser under
the laws of a State is an eligible investment adviser only if the State
has an examination requirement to qualify for such registration.
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As under present law, the provision applies only to amounts
for retirement planning advice and information and does not
apply to services that may be related to retirement planning,
such as tax preparation, accounting, legal or brokerage
services.
Under the provision, no amount is includible in gross
income or wages merely because the employee is offered the
choice of cash in lieu of eligible qualified retirement
planning services. Also, no amount is includible in income or
wages merely because the employee is offered a choice among
eligible qualified retirement planning services. The amount of
cash offered is includible in income and wages only to the
extent the employee elects cash. The exclusion does not apply
to highly compensated employees unless the salary reduction
option is available on substantially the same terms to all
employees normally provided education and information about the
plan.
Under the provision, salary reduction amounts used to
provide eligible qualified retirement planning services are
generally treated for pension plan purposes the same as other
salary reduction contributions. Thus, such amounts are included
in compensation for purposes of applying the limits on
contributions and benefits, and an employer is able to elect
whether or not to include such amounts in compensation for
nondiscrimination testing.
EFFECTIVE DATE
The provision is effective for taxable years beginning
after December 31, 2004, and before January 1, 2010.
TITLE III. PROTECTION OF PENSION PLAN PARTICIPANTS
A. Notice to Participants or Beneficiaries of Blackout Periods
(Sec. 301 of the bill, new sec. 4980J of the Code, and sec. 101(i) of
ERISA)
PRESENT LAW
In general
The Sarbanes-Oxley Act of 2002 \36\ amended ERISA to
require that the plan administrator of an individual account
plan \37\ provide advance notice of a blackout period (a
``blackout notice'') to plan participants and beneficiaries to
whom the blackout period applies.\38\ Generally, notice must be
provided at least 30 days before the beginning of the blackout
period. In the case of a blackout period that applies with
respect to employer securities, the plan administrator must
also provide timely notice of the blackout period to the
employer (or the affiliate of the employer that issued the
securities, if applicable).
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\36\ Pub. L. No. 107-204 (2002).
\37\ An ``individual account plan'' is the term generally used
under ERISA for a defined contribution plan.
\38\ ERISA sec. 101(i), as enacted by section 306(b) of the
Sarbanes-Oxley Act of 2002. Under section 306(a), a director or
executive officer of a publicly-traded corporation is prohibited from
trading in employer stock during blackout periods in certain
circumstances. Section 306 is effective 180 days after enactment.
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The blackout notice requirement does not apply to a one-
participant retirement plan, which is defined as a plan that
(1) on the first day of the plan year, covered only the
employer (and the employer's spouse) and the employer owns the
entire business (whether or not incorporated) or covers only
one or more partners (and their spouses) in a business
partnership (including partners in an S or C corporation as
defined in section 1361(a) of the Code), (2) meets the minimum
coverage requirements without being combined with any other
plan that covers employees of the business, (3) does not
provide benefits to anyone except the employer (and the
employer's spouse) or the partners (and their spouses), (4)
does not cover a business that is a member of an affiliated
service group, a controlled group of corporations, or a group
of corporations under common control, and (5) does not cover a
business that leases employees.\39\
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\39\ Governmental plans and church plans are exempt from ERISA.
Accordingly, the blackout notice requirement does not apply to these
plans.
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Definition of blackout period
A blackout period is any period during which any ability of
participants or beneficiaries under the plan, which is
otherwise available under the terms of the plan, to direct or
diversify assets credited to their accounts, or to obtain loans
or distributions from the plan, is temporarily suspended,
limited, or restricted if the suspension, limitation, or
restriction is for any period of more than three consecutive
business days. However, a blackout period does not include a
suspension, limitation, or restriction that (1) occurs by
reason of the application of securities laws, (2) is a change
to the plan providing for a regularly scheduled suspension,
limitation, or restriction that is disclosed through a summary
of material modifications to the plan or materials describing
specific investment options under the plan, or changes thereto,
or (3) applies only to one or more individuals, each of whom is
a participant, alternate payee, or other beneficiary under a
qualified domestic relations order.
Timing of notice
Notice of a blackout period is generally required at least
30 days before the beginning of the period. The 30-day notice
requirement does not apply if (1) deferral of the blackout
period would violate the fiduciary duty requirements of ERISA
and a plan fiduciary so determines in writing, or (2) the
inability to provide the 30-day advance notice is due to events
that were unforeseeable or circumstances beyond the reasonable
control of the plan administrator and a plan fiduciary so
determines in writing. In those cases, notice must be provided
as soon as reasonably practicable under the circumstances
unless notice in advance of the termination of the blackout
period is impracticable.
Another exception to the 30-day period applies in the case
of a blackout period that applies only to one or more
participants or beneficiaries in connection with a merger,
acquisition, divestiture, or similar transaction involving the
plan or the employer and that occurs solely in connection with
becoming or ceasing to be a participant or beneficiary under
the plan by reason of the merger, acquisition, divestiture, or
similar transaction. Under the exception, the blackout notice
requirement is treated as met if notice is provided to the
participants or beneficiaries to whom the blackout period
applies as soon as reasonably practicable.
The Secretary of Labor may provide additional exceptions to
the notice requirement that the Secretary determines are in the
interests of participants and beneficiaries.
Form and content of notice
A blackout notice must be written in a manner calculated to
be understood by the average plan participant and must include
(1) the reasons for the blackout period, (2) an identification
of the investments and other rights affected, (3) the expected
beginning date and length of the blackout period, and (4) in
the case of a blackout period affecting investments, a
statement that the participant or beneficiary should evaluate
the appropriateness of current investment decisions in light of
the inability to direct or diversify assets during the blackout
period, and (5) other matters as required by regulations. If
the expected beginning date or length of the blackout period
changes after notice has been provided, the plan administrator
must provide notice of the change (and specify any material
change in other matters related to the blackout) to affected
participants and beneficiaries as soon as reasonably
practicable.
Notices provided in connection with a blackout period (or
changes thereto) must be provided in writing and may be
delivered in electronic or other form to the extent that the
form is reasonably accessible to the recipient. The Secretary
of Labor is required to issue guidance regarding the notice
requirement and a model blackout notice.
Penalty for failure to provide notice
In the case of a failure to provide notice of a blackout
period, the Secretary of Labor may assess a civil penalty
against a plan administrator of up to $100 per day for each
failure to provide a blackout notice. For this purpose, each
violation with respect to a single participant or beneficiary
is treated as a separate violation.
Code requirements
The Code does not contain a notice requirement with respect
to blackouts. However, the Code contains a variety of other
notice requirements with respect to qualified plans. Such
requirements are generally enforced by an excise tax. For
example, in the case of a failure to provide notice of a
significant reduction in benefit accruals, an excise tax of
$100 a day is generally imposed on the employer. If the
employer exercised reasonable diligence in meeting the
requirements, the excise tax with respect to a taxable year is
limited to no more than $500,000.
REASONS FOR CHANGE
In the course of normal plan operation, periods may occur
during which a plan participant's ability to direct the
investment of his or her account or obtain loans or
distributions from the plan is restricted (a so-called
``blackout'' period). These periods usually occur in connection
with administrative changes, such as a change in recordkeepers
or in the investment options offered under a plan. Such a
period may result also from changes in the plan in connection
with a corporate transaction, such as a sale or merger. Present
law requires advance notice of a blackout period to plan
participants and beneficiaries to whom the blackout period
applies. The Committee believes that such blackout notices
serve an important purpose by allowing plan participants to
prepare for any restrictions that will occur during a blackout
period. The Committee believes that modifying the blackout
notice requirement to better match plan operations will improve
the notices. Additionally, enhancing enforcement of the
blackout notice requirement will ensure that all participants
receive blackout notices, and thus, have the opportunity to
prepare for any restrictions that will occur during a blackout
period.
At the request of the Committee, the Joint Committee staff
undertook an investigation relating to Enron Corporation and
related entities, including a review of the compensation
arrangements of Enron employees, e.g., qualified retirement
plans, nonqualified deferred compensation arrangements, and
other arrangements. The Joint Committee staff issued an
official report of its investigation,\40\ including findings
and recommendations resulting from its review of Enron's
pension plans and compensation arrangements. The Joint
Committee staff found that Enron provided a variety of advance
notices to plan participants explaining the proposed blackout;
however, the Joint Committee staff determined that not all
participants received the same notices. In particular, certain
active employees received additional reminders of the blackout
that were not sent to other participants.\41\ The Joint
Committee staff's findings support the Committee's views
regarding the need for plan participants to receive notice of
blackouts sufficient to allow them to make appropriate
decisions in anticipation of a blackout.
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\40\ Joint Committee on Taxation, Report of Investigation of Enron
Corporation and Related Entities Regarding Federal Tax and Compensation
Issues, and Policy Recommendations (JCS-3-03), February 2003.
\41\ Id. at Vol. I, 12-13, 38-38, 493-515.
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EXPLANATION OF PROVISION
In general
The provision amends the Code to include a blackout notice
requirement similar to the present law ERISA requirement and
makes certain modifications to the ERISA notice requirement.
The blackout notice requirement under the Code does not apply
to a one-participant retirement plan, a governmental plan, or a
church plan.\42\
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\42\ In the case of a tax-sheltered annuity (sec. 403(b)) that is
not a plan established or maintained by the employer, the blackout
notice generally must be provided by the issuer of the annuity
contract.
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Definition of blackout period
The provision also revises the definition of blackout
period under the Code and ERISA. The definition of blackout
period is revised to include a suspension, limitation, or
restriction of any ability of participants or beneficiaries to
direct or diversify assets credited to their accounts, or to
obtain loans or distributions from the plan, that is otherwise
available under the plan, without regard to whether the ability
is specifically provided for in the terms of the plan.
Definition of one-participant retirement plan
The provision clarifies the definition of a one-participant
retirement plan not subject to the blackout notice requirement.
Under the provision, for purposes of the blackout notice
requirements under the Code and ERISA, the definition is
conformed to the definition that applies under the provision
relating to diversification, thus clarifying that such a plan
covers only an individual (or the individual and his or her
spouse) who owns 100 percent of the plan sponsor (i.e., the
employer maintaining the plan), whether or not incorporated, or
covers only one or more partners (or partners and their
spouses) in the plan sponsor. For this purpose, a partner
includes an owner of a business that is treated as a
partnership for tax purposes and a two-percent shareholder of
an S corporation.
Excise tax for failure to provide notice
Under the provision, an excise tax is generally imposed on
the employer if a blackout notice is not provided as required
under the Code.\43\ The excise tax is $100 per day for each
applicable individual with respect to whom the failure
occurred, until notice is provided or the failure is otherwise
corrected. If the employer exercises reasonable diligence to
meet the notice requirements, the total excise tax imposed
during a taxable year will not exceed $500,000. No tax will be
imposed with respect to a failure if the employer does not know
that the failure existed and exercises reasonable diligence to
comply with the notice requirement. In addition, no tax will be
imposed if the employer exercises reasonable diligence to
comply and provides the required notice as soon as reasonably
practicable after learning of the failure. In the case of a
failure due to reasonable cause and not to willful neglect, the
Secretary of the Treasury is authorized to waive the excise tax
to the extent that the payment of the tax would be excessive or
otherwise inequitable relative to the failure involved.
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\43\ In the case of a multiemployer plan, the excise tax is imposed
on the plan. In the case of a tax-sheltered annuity (sec. 403(b)) that
is not a plan established or maintained by the employer, the excise tax
generally is imposed on the issuer of the annuity contract.
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EFFECTIVE DATE
The amendments to the Code apply to failures to provide the
required notice after the date of enactment. The amendments to
ERISA made by the provision are effective as if included in
section 306 of the Sarbanes-Oxley Act of 2002.
TITLE IV. OTHER PROVISIONS RELATING TO PENSIONS
A. Provisions Relating to Pension Plan Funding
1. Replacement of interest rate on 30-year Treasury securities used for
certain pension plan purposes (secs. 401-408 of the bill, secs.
401(a)(36), 404, 412, 415(b), and 417(e) of the Code, and secs.
205(g), 206, 302, and 4006 of ERISA)
PRESENT LAW \44\
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\44\ Present law refers to the law in effect on the dates of
Committee action on the bill. It does not reflect the changes made by
the Pension Funding Equity Act of 2004 (``PFEA 2004''), Pub. L. No.
108-218 (April 10, 2004). Section 101 of PFEA 2004 changes the interest
rates used for certain pension purposes for 2004 and 2005.
Specifically, it provides for the use of an interest rate based on
amounts invested conservatively in long-term corporate bonds for
purposes of determining current liability and PBGC variable rate
premiums for plan years beginning in 2004 and 2005. In addition, in the
case of plan years beginning in 2004 or 2005, in applying the limits on
benefits payable under a defined benefit pension plan to certain forms
of benefit, such as a lump sum, the interest rate used must be not less
than the greater of: (1) 5.5 percent; or (2) the interest rate
specified in the plan. Under section 102 of PFEA 2004, if certain
requirements are met, reduced contributions under the deficit reduction
contribution rules apply for plan years beginning after December 27,
2003, and before December 28, 2005, in the case of plans maintained by
commercial passenger airlines, employers primarily engaged in the
production or manufacture of a steel mill product or in the processing
of iron ore pellets, or a certain labor organization.
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In general
Under present law, the interest rate on 30-year Treasury
securities is used for several purposes related to defined
benefit pension plans. Specifically, the interest rate on 30-
year Treasury securities is used: (1) in determining current
liability for purposes of the funding and deduction rules; (2)
in determining unfunded vested benefits for purposes of Pension
Benefit Guaranty Corporation (``PBGC'') variable rate premiums;
and (3) in determining the minimum required value of lump-sum
distributions from a defined benefit pension plan and maximum
lump-sum values for purposes of the limits on benefits payable
under a defined benefit pension plan.
The IRS publishes the interest rate on 30-year Treasury
securities on a monthly basis. The Department of the Treasury
does not currently issue 30-year Treasury securities. As of
March 2002, the IRS publishes the average yield on the 30-year
Treasury bond maturing in February 2031 as a substitute.
Funding rules
In general
The Internal Revenue Code (the ``Code'') and the Employee
Retirement Income Security Act of 1974 (``ERISA'') impose
minimum funding requirements with respect to defined benefit
pension plans.\45\ Under the funding rules, the amount of
contributions required for a plan year is generally the plan's
normal cost for the year (i.e., the cost of benefits allocated
to the year under the plan's funding method) plus that year's
portion of other liabilities that are amortized over a period
of years, such as benefits resulting from a grant of past
service credit.
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\45\ Code sec. 412; ERISA sec. 302. The Code also imposes limits on
deductible contributions, as discussed below.
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Additional contributions for underfunded plans
Under special funding rules (referred to as the ``deficit
reduction contribution'' rules),\46\ an additional contribution
to a plan is generally required if the plan's funded current
liability percentage is less than 90 percent.\47\ A plan's
``funded current liability percentage'' is the actuarial value
of plan assets \48\ as a percentage of the plan's current
liability. In general, a plan's current liability means all
liabilities to employees and their beneficiaries under the
plan.
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\46\ The deficit reduction contribution rules apply to single-
employer plans, other than single-employer plans with no more than 100
participants on any day in the preceding plan year. Single-employer
plans with more than 100 but not more than 150 participants are
generally subject to lower contribution requirements under these rules.
\47\ Under an alternative test, a plan is not subject to the
deficit reduction contribution rules for a plan year if (1) the plan's
funded current liability percentage for the plan year is at least 80
percent, and (2) the plan's funded current liability percentage was at
least 90 percent for each of the two immediately preceding plan years
or each of the second and third immediately preceding plan years.
\48\ The actuarial value of plan assets is the value determined
under an actuarial valuation method that takes into account fair market
value and meets certain other requirements. The use of an actuarial
valuation method allows appreciation or depreciation in the market
value of plan assets to be recognized gradually over several plan
years. Sec. 412(c)(2); Treas. reg. sec. 1.412(c)(2)-1.
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The amount of the additional contribution required under
the deficit reduction contribution rules is the sum of two
amounts: (1) the excess, if any, of (a) the deficit reduction
contribution (as described below), over (b) the contribution
required under the normal funding rules; and (2) the amount (if
any) required with respect to unpredictable contingent
eventbenefits.\49\ The amount of the additional contribution cannot
exceed the amount needed to increase the plan's funded current
liability percentage to 100 percent.
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\49\ A plan may provide for unpredictable contingent event
benefits, which are benefits that depend on contingencies that are not
reliably and reasonably predictable, such as facility shutdowns or
reductions in workforce. An additional contribution is generally not
required with respect to unpredictable contingent event benefits unless
the event giving rise to the benefits has occurred.
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The deficit reduction contribution is the sum of (1) the
``unfunded old liability amount,'' (2) the ``unfunded new
liability amount,'' and (3) the expected increase in current
liability due to benefits accruing during the plan year.\50\
The ``unfunded old liability amount'' is the amount needed to
amortize certain unfunded liabilities under 1987 and 1994
transition rules. The ``unfunded new liability amount'' is the
applicable percentage of the plan's unfunded new liability.
Unfunded new liability generally means the unfunded current
liability of the plan (i.e., the amount by which the plan's
current liability exceeds the actuarial value of plan assets),
but determined without regard to certain liabilities (such as
the plan's unfunded old liability and unpredictable contingent
event benefits). The applicable percentage is generally 30
percent, but is reduced if the plan's funded current liability
percentage is greater than 60 percent.
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\50\ If the Secretary of the Treasury prescribes a new mortality
table to be used in determining current liability, as described below,
the deficit reduction contribution may include an additional amount.
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Required interest rate and mortality table
Specific interest rate and mortality assumptions must be
used in determining a plan's current liability for purposes of
the special funding rule. The interest rate used to determine a
plan's current liability must be within a permissible range of
the weighted average \51\ of the interest rates on 30-year
Treasury securities for the four-year period ending on the last
day before the plan year begins. The permissible range is
generally from 90 percent to 105 percent.\52\ The interest rate
used under the plan must be consistent with the assumptions
which reflect the purchase rates which would be used by
insurance companies to satisfy the liabilities under the
plan.\53\
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\51\ The weighting used for this purpose is 40 percent, 30 percent,
20 percent and 10 percent, starting with the most recent year in the
four-year period. Notice 88-73, 1988-2 C.B. 383.
\52\ If the Secretary of the Treasury determines that the lowest
permissible interest rate in this range is unreasonably high, the
Secretary may prescribe a lower rate, but not less than 80 percent of
the weighted average of the 30-year Treasury rate.
\53\ Code sec. 412(b)(5)(B)(iii)(II); ERISA sec.
302(b)(5)(B)(iii)(II). Under Notice 90-11, 1990-1 C.B. 319, the
interest rates in the permissible range are deemed to be consistent
with the assumptions reflecting the purchase rates that would be used
by insurance companies to satisfy the liabilities under the plan.
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The Job Creation and Worker Assistance Act of 2002 \54\
amended the permissible range of the statutory interest rate
used in calculating a plan's current liability for purposes of
applying the additional contribution requirements. Under this
provision, the permissible range is from 90 percent to 120
percent for plan years beginning after December 31, 2001, and
before January 1, 2004.
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\54\ Pub. L. No. 107-147.
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The Secretary of the Treasury is required to prescribe
mortality tables and to periodically review (at least every
five years) and update such tables to reflect the actuarial
experience of pension plans and projected trends in such
experience.\55\ The Secretary of the Treasury has required the
use of the 1983 Group Annuity Mortality Table.\56\
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\55\ Code sec. 412(l)(7)(C)(ii); ERISA sec. 302(d)(7)(C)(ii).
\56\ Rev. Rul. 95-28, 1995-1 C.B. 74. The IRS and the Treasury
Department have announced that they are undertaking a review of the
applicable mortality table and have requested comments on related
issues, such as how mortality trends should be reflected. Notice 2003-
62, 2003-38 I.R.B. 576; Announcement 2000-7, 2000-1 C.B. 586.
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Full funding limitation
No contributions are required under the minimum funding
rules in excess of the full funding limitation. In 2004 and
thereafter, the full funding limitation is the excess, if any,
of (1) the accrued liability under the plan (including normal
cost), over (2) the lesser of (a) the market value of plan
assets or (b) the actuarial value of plan assets.\57\ However,
the full funding limitation may not be less than the excess, if
any, of 90 percent of the plan's current liability (including
the current liability normal cost) over the actuarial value of
plan assets. In general, current liability is all liabilities
to plan participants and beneficiaries accrued to date, whereas
the accrued liability under the full funding limitation may be
based on projected future benefits, including future salary
increases.
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\57\ For plan years beginning before 2004, the full funding
limitation was generally defined as the excess, if any, of (1) the
lesser of (a) the accrued liability under the plan (including normal
cost) or (b) a percentage (170 percent for 2003) of the plan's current
liability (including the current liability normal cost), over (2) the
lesser of (a) the market value of plan assets or (b) the actuarial
value of plan assets, but in no case less than the excess, if any, of
90 percent of the plan's current liability over the actuarial value of
plan assets. Under the Economic Growth and Tax Relief Reconciliation
Act of 2001 (``EGTRRA''), the full funding limitation based on 170
percent of current liability is repealed for plan years beginning in
2004 and thereafter. The provisions of EGTRRA generally do not apply
for years beginning after December 31, 2010.
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Timing of plan contributions
In general, plan contributions required to satisfy the
funding rules must be made within 8\1/2\ months after the end
of the plan year. If the contribution is made by such due date,
the contribution is treated as if it were made on the last day
of the plan year.
In the case of a plan with a funded current liability
percentage of less than 100 percent for the preceding plan
year, estimated contributions for the current plan year must be
made in quarterly installments during the current plan
year.\58\ The amount of each required installment is 25 percent
of the lesser of (1) 90 percent of the amount required to be
contributed for the current plan year or (2) 100 percent of the
amount required to be contributed for the preceding plan
year.\59\
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\58\ Code sec. 412(m); ERISA sec. 302(e).
\59\ In connection with the expanded interest rate range available
for 2002 and 2003, special rules apply in determining current liability
for the preceding plan year for purposes of applying the quarterly
contributions requirements to plan years beginning in 2002 (when the
expanded range first applies) and 2004 (when the expanded range no
longer applies). In each of those years (``present year''), current
liability for the preceding year is redetermined, using the permissible
range applicable to the present year. This redetermined current
liability will be used for purposes of the plan's funded current
liability percentage for the preceding year, which may affect the need
to make quarterly contributions, and for purposes of determining the
amount of any quarterly contributions in the present year, which is
based in part on the preceding year.
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Funding waivers
Within limits, the IRS is permitted to waive all or a
portion of the contributions required under the minimum funding
standard for a plan year.\60\ A waiver may be granted if the
employer (or employers) responsible for the contribution could
not make the required contribution without temporary
substantial business hardship and if requiring the contribution
would be adverse to the interests of plan participants in the
aggregate. Generally, no more than three waivers may be granted
within any period of 15 consecutive plan years.
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\60\ Code sec. 412(d); ERISA sec. 303.
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If a funding waiver is in effect for a plan, subject to
certain exceptions, no plan amendment may be adopted that
increases the liabilities of the plan by reason of any increase
in benefits, any change in the accrual of benefits, or any
change in the rate at which benefits vest under the plan. In
addition, the IRS is authorized to require security to be
granted as a condition of granting a funding waiver if the sum
of the plan's accumulated funding deficiency and the balance of
any outstanding waived funding deficiencies exceeds $1 million.
Excise tax
An employer is generally subject to an excise tax if it
fails to make minimum required contributions and fails to
obtain a waiver from the IRS.\61\ The excise tax is generally
10 percent of the amount of the funding deficiency. In
addition, a tax of 100 percent may be imposed if the funding
deficiency is not corrected within a certain period.
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\61\ Code sec. 4971.
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Deductions for contributions
Employer contributions to qualified retirement plans are
deductible, subject to certain limits. In the case of a defined
benefit pension plan, the employer generally may deduct the
greater of: (1) the amount necessary to satisfy the minimum
funding requirement of the plan for the year; or (2) the amount
of the plan's normal cost for the year plus the amount
necessary to amortize certain unfunded liabilities over 10
years, but limited to the full funding limitation for the
year.\62\ However, the maximum amount of deductible
contributions is generally not less than the plan's unfunded
current liability.\63\
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\62\ Code sec. 404(a)(1).
\63\ Code sec. 404(a)(1)(D). In the case of a plan that terminates
during the year, the maximum deductible amount is generally not less
than the amount needed to make the plan assets sufficient to fund
benefit liabilities as defined for purposes of the PBGC termination
insurance program (sometimes referred to as ``termination liability'').
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PBGC premiums
Because benefits under a defined benefit pension plan may
be funded over a period of years, plan assets may not be
sufficient to provide the benefits owed under the plan to
employees and their beneficiaries if the plan terminates before
all benefits are paid. The PBGC generally insures the benefits
owed under defined benefit pension plans (up to certain limits)
in the event a plan is terminated with insufficient assets.
Employers pay premiums to the PBGC for this insurance coverage.
PBGC premiums include a flat-rate premium and, in the case
of an underfunded plan, a variable rate premium based on the
amount of unfunded vested benefits.\64\ In determining the
amount of unfunded vested benefits, the interest rate used is
85 percent of the annual yield on 30-year Treasury securities
for the month preceding the month in which the plan year
begins.
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\64\ ERISA sec. 4006.
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Under the Job Creation and Worker Assistance Act of 2002,
for plan years beginning after December 31, 2001, and before
January 1, 2004, the interest rate used in determining the
amount of unfunded vested benefits for PBGC variable rate
premium purposes is increased to 100 percent of the annual
yield on 30-year Treasury securities for the month preceding
the month in which the plan year begins.
Lump-sum distributions
Accrued benefits under a defined benefit pension plan
generally must be paid in the form of an annuity for the life
of the participant unless the participant consents to a
distribution in another form. Defined benefit pension plans
generally provide that a participant may choose among other
forms of benefit offered under the plan, such as a lump-sum
distribution. These optional forms of benefit generally must be
actuarially equivalent to the life annuity benefit payable to
the participant.
A defined benefit pension plan must specify the actuarial
assumptions that will be used in determining optional forms of
benefit under the plan in a manner that precludes employer
discretion in the assumptions to be used. For example, a plan
may specify that a variable interest rate will be used in
determining actuarial equivalent forms of benefit, but may not
give the employer discretion to choose the interest rate.
Statutory assumptions must be used in determining the
minimum value of certain optional forms of benefit, such as a
lump sum.\65\ That is, the lump sum payable under the plan may
not be less than the amount of the lump sum that is actuarially
equivalent to the life annuity payable to the participant,
determined using the statutory assumptions. The statutory
assumptions consist of an applicable mortality table (as
published by the IRS) and an applicable interest rate.
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\65\ Code sec. 417(e)(3); ERISA sec. 205(g)(3).
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The applicable interest rate is the annual rate of interest
on 30-year Treasury securities, determined as of the time that
is permitted under regulations. The regulations provide various
options for determining the interest rate to be used under the
plan, such as the period for which the interest rate will
remain constant (``stability period'') and the use of
averaging.
Limits on benefits
Annual benefits payable under a defined benefit pension
plan generally may not exceed the lesser of (1) 100 percent of
average compensation, or (2) $165,000 (for 2004).\66\ The
dollar limit generally applies to a benefit payable in the form
of a straight life annuity beginning no earlier than age 62.
The limit is reduced if benefits are paid before age 62. In
addition, if the benefit is not in the form of a straight life
annuity, the benefit generally is adjusted to an equivalent
straight life annuity. In making these reductions and
adjustments, the interest rate used generally must be not less
than the greater of: (1) five percent; or (2) the interest rate
specified in the plan. However, for purposes of adjusting a
benefit in a form that is subject to the minimum value rules
(including the use of the interest rate on 30-year Treasury
securities), such as a lump-sum benefit, the interest rate used
must be not less than the greater of: (1) the interest rate on
30-year Treasury securities; or (2) the interest rate specified
in the plan.
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\66\ Code sec. 415(b).
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REASONS FOR CHANGE
The Treasury Department no longer issues 30-year Treasury
securities, making it necessary to provide a replacement rate
for pension purposes. The Committee considers interest rates on
high-quality corporate bonds to be an appropriate replacement.
However, the Committee believes that a more accurate
calculation would result from matching interest rates to the
timing of expected payments than using a single long-term
interest rate. Accordingly, a yield curve that reflects the
rates of interest on corporate bonds of varying maturities
should be used for pension purposes.
The Committee recognizes that a change in interest rates
used to calculate lump sum payments to participants and
beneficiaries must be phased in gradually so participants are
not forced to make hasty decisions about the timing of
retirement. A deferred effective date followed by a phase-in
period for the yield curve would give participants adequate
time to review the impact of the change in interest rates.
The Committee believes that the deficit reduction
contribution rules play an important role in assuring that
pension plans are adequately funded. However, in recent years,
a combination of sharp declines in plan asset values and
unusually low interest rates has resulted in large additional
contribution requirements in the case of plans that were not
previously subject to the deficit reduction contribution rules.
Making such additional contributions may have the effect of
diverting funds from other business uses, which could force
some companies into bankruptcy or to consider freezing or
terminating their pension plans, thereby further weakening the
pension system and the financial status of the PBGC. The
Committee thus believes that employers should be provided
temporary relief from such additional contributions. The
Committee also believes that the deductible contribution limit
should be increased to allow plan sponsors to contribute more
in good times and thereby be able to contribute less in bad
times.
The Committee is also concerned about seriously underfunded
plans maintained by employers experiencing ongoing financial
uncertainty. Such plans present a risk to employees, as well as
to the PBGC insurance program and to other PBGC premium payors.
The Committee believes that appropriate restrictions should
apply to limit the risk presented by such plans.
EXPLANATION OF PROVISION
Interest rate used to determine current liability and PBGC premiums
In general
The provision changes the interest rate used in determining
current liability for funding and deduction purposes and in
determining PBGC variable rate premiums for plan years
beginning after December 31, 2003. The interest rate used for
these purposes is based on rates of interest on high-quality
corporate bonds. For plan years beginning before January 1,
2007, the interest rate is based on amounts invested in high-
quality long-term corporate bonds. For subsequent years,
interest rates are determined using a yield curve method that
matches interest rates drawn from a yield curve based on high-
quality corporate bonds with the timing of expected benefit
payments under the plan. The yield curve method is phased in
over five years.
Current liability for 2004-2006
For purposes of determining a plan's current liability for
plan years beginning in 2004, 2005, and 2006, the interest rate
used must be within a permissible range of the weighted average
of conservative long-term corporate bond rates during the four-
year period ending on the last day before the plan year begins.
The permissible range for these years is from 90 percent to 100
percent. For purposes of determining the four-year weighted
average, the weighting applicable under present law applies
(i.e., 40 percent, 30 percent, 20 percent and 10 percent,
starting with the most recent year in the four-year period).
The Secretary of the Treasury is directed to prescribe by
regulation a method for periodically determining conservative
long-term corporate bond rates for this purpose. The rates are
to reflect rates of interest on amounts invested in high-
quality long-term corporate bonds and are to be based on the
use of one or more indices as determined from time to time by
the Secretary. For this purpose, it is intended that high-
quality corporate bonds are generally those in the top two
quality levels available, but may include the third quality
level as the Secretary deems appropriate.
Current liability after 2006
For plan years beginning after 2006, current liability is
determined using the yield curve method, which is phased in
over five years.
The yield curve method is a method under which current
liability is determined: (1) using interest rates drawn from a
yield curve prescribed by the Secretary of the Treasury that
reflects interest rates on high-quality corporate bonds of
varying maturities; and (2) by matching the timing of the
expected benefit payments under the plan to the interest rates
on the yield curve (i.e., for bonds with maturity dates
comparable to the times when benefits are expected to be paid).
The Secretary of the Treasury is directed to publish any yield
curve prescribed under the provision and the method of
determining the yield curve, including the period of time for
which interest rates are taken into account in determining the
yield curve and the frequency with which a new yield curve is
prescribed. For example, the Secretary may prescribe the yield
curve on a monthly basis, to be applied for plan years
beginning in the following month.
Under the phase-in yield curve method applicable for plan
years beginning in 2007-2010, current liability for a plan year
equals the sum of two amounts: (1) the applicable percentage of
current liability determined under the yield curve method; and
(2) current liability determined using an interest rate in the
permissible range of the weighted four-year average of
conservative long-term corporate bond rates (i.e., the interest
rate applicable for plan years beginning in 2004-2006),
multiplied by a percentage equal to 100 percent minus the
applicable percentage for the plan year. For this purpose, the
applicable percentage for a plan year is determined in
accordance with the following table.
TABLE 2.--APPLICABLE PERCENTAGE FOR PLAN YEARS BEGINNING IN 2007-2010
------------------------------------------------------------------------
Applicable
Plan years beginning in: percentage
------------------------------------------------------------------------
2007....................................................... 20
2008....................................................... 40
2009....................................................... 60
2010....................................................... 80
------------------------------------------------------------------------
Thus, for example, for plan years beginning in 2008,
current liability under the phase-in yield curve method is the
sum of: (1) 40 percent of current liability determined under
the yield curve method, and (2) 60 percent of current liability
determined using an interest rate in the permissible range of
the weighted four-year average of conservative long-term
corporate bond rates.
The Secretary of the Treasury is directed to prescribe one
or more simplified methods, in lieu of the yield curve method,
for use in determining current liability. Such a simplified
method may be used by a plan (other than a multiemployer plan)
if, on each day during the preceding plan year, the plan had no
more than 100 participants.\67\ A simplified method may apply
for purposes of both the yield curve method and the phase-in
yield curve method.
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\67\ All defined benefit pension plans maintained by the same
employer are treated as a single plan for this purpose.
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PBGC variable rate premiums
For plan years beginning in 2004, 2005, or 2006, the
interest rate used in determining the amount of unfunded vested
benefits is the conservative long-term corporate bond rate (as
determined by the Secretary of the Treasury) for the month
preceding the month in which the plan year begins. For years
after 2006, the interest rate or method applicable in
determining current liability for a plan year also applies in
determining the amount of unfunded vested benefits for the plan
year for purposes of determining PBGC variable rate premiums.
Thus, the phase-in yield curve method applies for plan years
beginning in 2007 through 2010, and the yield curve method
applies for plan years beginning after 2010. In addition, any
simplified method prescribed by the Secretary of the Treasury
may be used instead of the phase-in yield curve method or the
yield curve method in determining the amount of unfunded vested
benefits (without regard to the number of participants covered
by the plan).
Interest rate used to determine minimum lump-sum benefits
For plan years beginning in 2007 through 2010, the phase-in
yield curve method generally applies in determining the amount
of a benefit in a form that is subject to the minimum value
rules, such as a lump-sum benefit, except that the annual rate
of interest on 30-year Treasury securities is substituted for
the conservative long-term corporate bond rate. Thus, for
example, for plan years beginning in 2008, a lump-sum benefit
payable under a plan may not be less than the sum of: (1) 40
percent of the minimum lump-sum benefit determined under the
yield curve method, and (2) 60 percent of the minimum lump-sum
benefit determined using the annual rate of interest on 30-year
Treasury securities.
For plan years beginning after 2010, the yield curve method
generally applies in determining the amount of a benefit in a
form that is subject to the minimum value rules.
Any simplified method prescribed by the Secretary of the
Treasury to be used instead of the yield curve method in
determining current liability may also be used in determining
minimum lump-sum benefits (without regard to the number of
participants covered by the plan). It is intended that, for
this purpose, the Secretary may prescribe a factor to be used
that combines the required interest rate and mortality
assumptions applicable under the minimum value rules. If a plan
provides for the use of a simplified method for purposes of
calculating lump-sum benefits, the simplified method must apply
consistently to all participants and to all lump sums.A plan
may be amended to change the method used to determine lump-sum benefits
(e.g., from the yield curve method to a simplified method or from one
simplified method to another), subject to the anticutback rules
generally prohibiting the elimination of optional forms of benefit, as
well as the nondiscrimination rules regarding the timing of plan
amendments.
Under the provision of the bill relating to plan amendments
(sec. 471 of the bill), a plan amendment made pursuant to a
provision of the bill generally will not violate the
anticutback rule if certain requirements are met (e.g., the
plan amendment is made on or before the last day of the first
plan year beginning on or after January 1, 2006). Thus, subject
to those requirements, a plan amendment will not violate the
anticutback rule merely because it provides for the use of the
phase-in yield curve method and the yield curve method, or a
simplified method, rather than the interest rate on 30-year
Treasury securities, in determining benefits subject to the
minimum value rules.
Interest rate used to apply benefit limits to lump sums
Under the provision, in adjusting a form of benefit that is
subject to the minimum value rules, such as a lump-sum benefit,
for purposes of applying the limits on benefits payable under a
defined benefit pension plan (sec. 415), the interest rate used
must be not less than the greater of: (1) 5.5 percent; or (2)
the interest rate specified in the plan.\68\
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\68\ In the case of a plan that provides lump-sum benefits
determined solely as required under the minimum value rules (rather
than using an interest rate that results in larger lump-sum benefits),
the interest rate specified in the plan is the interest rate or method
applicable under the minimum value rules. Thus, for purposes of
applying the benefit limits to lump-sum benefits under the plan, the
interest rate used must be not less than the greater of: (1) 5.5
percent; or (2) the interest rate or method applicable under the
minimum value rules.
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Under the provision of the bill relating to plan amendments
(sec. 471 of the bill), a plan amendment made pursuant to a
provision of the bill generally will not violate the
anticutback rule if certain requirements are met (e.g., the
plan amendment is made on or before the last day of the first
plan year beginning on or after January 1, 2006). Thus, subject
to those requirements, a plan amendment made pursuant to the
provision relating to the interest rate used to apply the
benefit limits to lump-sum benefits generally will not violate
the anticutback rule.\69\
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\69\ A special transition rule, described below, applies for 2004
and 2005.
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Deficit reduction contribution relief
Under the provision, if a plan was not subject to the
deficit reduction contribution rules for the plan year
beginning in 2000, the deficit reduction contribution rules do
not apply to the plan for plan years beginning in 2004, 2005,
or 2006.\70\ Thus, with respect to such a plan, no additional
contributions are required under the deficit reduction
contribution rules for these years.
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\70\ Whether a plan was subject to the deficit reduction
contribution rules for the plan year beginning in 2000 is determined
without regard to the rule that allows the temporary conservative long-
term corporate bond rate to be used for lookback rule purposes, as
discussed below.
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Deduction limits for plan contributions
The provision increases the limit on deductions for
contributions to a defined benefit pension plan. Under the
provision, the maximum amount otherwise deductible is not less
than the excess (if any) of (1) 130 percent of the plan's
current liability, over (2) the value of plan assets.
Benefit limitations for financially distressed plans
Under the provision, certain limitations apply to a defined
benefit pension plan that is subject to the deficit reduction
contribution rules if the plan is a financially distressed plan
for a plan year.\71\
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\71\ The provision does not apply to plans that are not subject to
the deficit reduction contribution rules, i.e., multiemployer plans and
single-employer plans with no more than 100 participants on any day in
the preceding plan year.
---------------------------------------------------------------------------
A plan is a financially distressed plan for a plan year if:
(1) the plan sponsor during any two of the five immediately
preceding plan years has an outstanding debt instrument that is
rated speculative grade or lower by one or more nationally
recognized statistical rating organizations for corporate
bonds; and (2) the funded liability percentage of the plan as
of the beginning of the preceding plan year is less than 50
percent.\72\ Once a plan is a financially distressed plan, the
plan continues to be treated as a financially distressed plan
for subsequent plan years that begin before the first plan year
beginning after: (1) a five-consecutive-year period during
which the plan sponsor has no outstanding debt instrument that
is rated speculative grade or lower; or (2) a five-consecutive-
year period during which the funded liability percentage of the
plan as of the beginning of the preceding plan year is at least
50 percent. The Secretary of the Treasury is directed to
prescribe rules for applying the definition of a financially
distressed plan in cases in which a plan sponsor's outstanding
debt instruments are not rated.
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\72\ For this purpose, funded liability percentage is determined
taking into account only vested benefits and using the interest rate
applicable in determining PBGC variable rate premiums and the fair
market value of the plan assets.
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Under the provision, if the plan is a financially
distressed plan for a plan year, the following limitations
apply:
(1) Restrictions on benefit increases.--No plan amendment
may take effect during the plan year if the amendment increases
plan liabilities by reason of any increase in benefits, any
change in the accrual of benefits, or any change in the rate at
which benefits vest under the plan. If a plan amendment is
adopted in violation of this limitation, the provisions of the
plan are to be applied without regard to the amendment.
(2) Freezing and elimination of benefits.--Each
participant's accrued benefit, any death or disability
benefits, and any social security supplement\73\ under the plan
must be frozen as of the end of the preceding year. Such
benefits are determined without regard to any plan amendment
adopted during the preceding plan year that increased benefits
and are determined after the application of this limitation if
it applied for the preceding year. In addition, all other
benefits provided under the plan must be eliminated. Freezing
or elimination of benefits is required only to the extent that
the implementation of the benefit freeze or elimination by a
plan amendment adopted at the end of the preceding plan year
would have been permitted under the anticutback rules.
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\73\ For this purpose, social security supplement has the meaning
as described in Code section 411(a)(9).
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(3) Restrictions on distributions.--In the case of a
participant or beneficiary whose annuity starting date occurs
in the plan year, the plan may not make: (a) any payment in
excess of the monthly amount paid under a single life annuity
(plus any social security supplement provided under the plan);
(b) any payment for the purchase of an irrevocable commitment
from an insurer to pay benefits (e.g., an annuity contract); or
(c) any other payment specified by the Secretary of the
Treasury by regulations.\74\ This restriction continues to for
the period during which the plan is a financially distressed
plan.
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\74\ Permissible distributions are determined by reference to Code
section 401(a)(32)(B) and ERISA section 206(e)(2) (relating to payments
if a plan has a liquidity shortfall).
---------------------------------------------------------------------------
If a plan is a financially distressed plan for a plan year,
but the plan's funded current liability percentage as of the
beginning of the preceding plan year is at least 50 percent,
the requirement that benefits be frozen or eliminated as
described in (2) above no longer applies. Thus, benefits under
the plan are determined without regard to any freezing or
elimination of benefits that was required as a result of
financially distressed plan status. In addition, a plan
amendment that increases plan liabilities by reason of any
increase in benefits, any change in the accrual of benefits, or
any change in the rate at which benefits vest under the plan
may take effect, but only if the funded current liability
percentage as of the end of the plan year is projected to be at
least 50 percent (taking into account the effect of the
amendment).
These limitations generally apply for the first plan year
for which a plan is a financially distressed plan. However, in
the case of a plan maintained pursuant to a collective
bargaining agreement that is in effect before the beginning of
the first plan year for which a plan is a financially
distressed plan, the limitations do not apply to plan benefits
pursuant to, and individuals covered by, the agreement for plan
years beginning before the date on which the agreement
terminates (determined without regard to any extension of the
agreement).
If a plan is a financially distressed plan for a plan year,
the employer must, at least 45 days before the beginning of the
plan year, provide notice to each plan participant and
beneficiary, each labor organization representing such
participants or beneficiaries, and the PBGC. The notice must
explain: (1) that the plan is treated as a financially
distressed plan and the reasons why it is so treated; and (2)
the restrictions applicable to the plan for the plan year as a
result of financially distressed status. The notice must be
provided in a form and manner as prescribed by the Secretary of
the Treasury. The Secretary may provide for the coordination of
this notice requirement with the notice required if a plan is
amended to provide for a significant reduction in the rate of
future benefit accrual. The notice must be written in a manner
so as to be understood by the average plan participant and may
be provided in written, electronic, or other appropriate form
to the extent that such form is reasonably accessible to the
person to whom notice is required to be provided. An employer
that fails to provide the required notice to a participant,
beneficiary, or the PBGC may (in the discretion of a court) be
liable to the participant, beneficiary, or PBGC in the amount
of up to $100 a day from the date of the failure, and the court
may in its discretion order such other relief as it deems
proper.
Treasury recommendations
The Secretary of the Treasury is required by December 31,
2004, to submit recommendations for future changes to the
funding rules to strengthen the funded status of plans,
including recommendations relating to the disclosure of funded
status. Such recommendations are to be submitted to the Senate
Committees on Finance and Health, Education, Labor, and
Pensions and to the House Committees on Ways and Means and
Education and the Workforce.
EFFECTIVE DATE
Interest rate used to determine current liability and PBGC premiums
The provision is generally effective for plan years
beginning after December 31, 2003. For purposes of applying
certain rules (``lookback rules'') to plan years beginning
after December 31, 2003, the amendments made by the provision
may be applied as if they had been in effect for all years
beginning before the effective date. For purposes of the
provision, ``lookback rules'' means: (1) the rule under which a
plan is not subject to the additional funding requirements for
a plan year if the plan's funded current liability percentage
was at least 90 percent for each of the two immediately
preceding plan years or each of the second and third
immediately preceding plan years; and (2) the rule under which
quarterly contributions are required for a plan year if the
plan's funded current liability percentage was less than 100
percent for the preceding plan year. The Secretary of the
Treasury may prescribe simplified assumptions that may be used
in applying the provision for prior plan years for purposes of
the lookback rules. The amendments made by the provision may be
applied for purposes of the lookback rules, regardless of the
funded current liability percentage reported for the plan on
the plan's annual reports (i.e., Form 5500) for preceding
years.
Interest rate used to determine minimum lump-sum benefits
The provision is effective for plan years beginning after
December 31, 2006.
The provision provides a special rule that allows a plan
amendment to change the interest rate used to determine certain
optional forms of benefit. Under the special rule, a plan
amendment will not violate the anticutback rule if: (1) for the
last plan year beginning in 2003, the plan provides that the
annual rate of interest on 30-year Treasury securities is used
indetermining the amount of a benefit (other than the accrued
benefit) that is not subject to the minimum value rules; (2) the plan
is amended to provide that a different rate of interest is used in
determining the amount of such benefit; and (3) the first plan year for
which such amendment is effective begins no later than January 1, 2007.
The provision of the bill relating to plan amendments (sec. 471 of the
bill) applies to a plan amendment made pursuant to the special rule.
Interest rate used to apply benefit limits to lump sums
The provision is generally effective for years beginning
after December 31, 2003. In the case of years beginning in 2004
or 2005, the provision does not apply if a greater benefit is
permitted by applying the benefit limits without regard to the
provision.
Deficit reduction contribution relief
The provision is effective on the date of enactment.
Deduction limits for plan contributions
The provision is effective for years beginning after
December 31, 2003.
Benefit limitations for certain financially distressed plans
The provision relating to benefit limitations for
financially distressed plans is generally effective for plan
years beginning after December 31, 2006. The Secretary of the
Treasury is directed to issue rules implementing this provision
by December 31, 2005.
In the case of a plan maintained pursuant to one or more
collective bargaining agreements ratified by the date of
enactment, the provision does not apply to employees covered by
such an agreement for plan years beginning before the later of
(1) the date on which the last of such agreements terminates
(determined without regard to any extension thereof on or after
the date of enactment), or (2) January 1, 2007.
Treasury recommendations
The provision directing the Secretary of the Treasury to
submit recommendations relating to the funding rules is
effective on the date of enactment.
2. Updating deduction rules for combination of plans (sec. 409 of the
bill and secs. 404(e)(7) and 4972 of the Code)
PRESENT LAW
Employer contributions to qualified retirement plans are
deductible subject to certain limits.\75\ In general, the
deduction limit depends on the kind of plan.
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\75\ Sec. 404
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In the case of a defined benefit pension plan, the employer
generally may deduct the greater of: (1) the amount necessary
to satisfy the minimum funding requirement of the plan for the
year; or (2) the amount of the plan's normal cost for the year
plus the amount necessary to amortize certain unfunded
liabilities over ten years, but limited to the full funding
limitation for the year. However, the maximum amount of
deductible contributions is generally not less than the plan's
unfunded current liability.\76\
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\76\ In the case of a plan that terminates during the year, the
maximum deductible amount is generally not less than the amount needed
to make the plan assets sufficient to fund benefit liabilities as
defined for purposes of the PBGC termination insurance program.
---------------------------------------------------------------------------
In the case of a defined contribution plan, the employer
generally may deduct contributions in an amount up to 25
percent of compensation paid or accrued during the employer's
taxable year.
If an employer sponsors one or more defined benefit plans
and one or more defined contribution plans that cover at least
one of the same employees, an overall deduction limit applies
to the total contributions to all plans for a plan year.\77\
The overall deduction limit generally is the greater of (1) 25
percent of compensation, or (2) the amount necessary to meet
the minimum funding requirements of the defined benefit plan
for the year (or the amount of either the plan's unfunded
current liability or the plan's unfunded termination liability
in the case of a terminating plan).
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\77\ Sec. 404(a)(7).
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Under EGTRRA, elective deferrals are not subject to the
limits on deductions and are not taken into account in applying
the limits to other employer contributions.\78\ The combined
deduction limit of 25 percent of compensation for defined
benefit and defined contribution plans does not apply if the
only amounts contributed to the defined contribution plan are
elective deferrals.
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\78\ Sec. 404(n). The provisions of EGTRRA generally do not apply
for years beginning after December 31, 2010.
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Subject to certain exceptions, an employer that makes
nondeductible contributions to a plan is subject to an excise
tax equal to 10 percent of the amount of the nondeductible
contributions for the year.\79\ Certain contributions to a
defined contribution plan that are nondeductible solely because
of the overall deduction limit are disregarded in determining
the amount of nondeductible contributions for purposes of the
excise tax. Contributions that are disregarded are the greater
of (1) the amount of contributions not in excess of six percent
of the compensation of the employees covered by the defined
contribution plan, or (2) the sum of matching contributions and
elective deferrals.
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\79\ Sec. 4972.
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REASONS FOR CHANGE
The Committee understands that many employers are required
to make substantial contributions to their defined benefit
pension plans and that in such cases the overall limit on
employer deductions for contributions to combinations of
defined benefit and defined contribution plans can operate to
reduce the deduction attributable to contributions to defined
contribution plans. The Committee believes that stability in
the ability to make deductible defined contribution plan
contributions up to certain levels is desirable.
EXPLANATION OF PROVISION
Under the provision, the overall limit on employer
deductions for contributions to combinations of defined benefit
and defined contribution plans applies to contributions to one
or more defined contribution plans only to the extent that such
contributions exceed six percent of compensation otherwise paid
or accrued during the taxable year to the beneficiaries under
the plans.
In addition, under the provision, for purposes of
determining the excise tax on nondeductible contributions,
matching contributions to a defined contribution plan that are
nondeductible solely because of the overall deduction limit are
disregarded.
EFFECTIVE DATE
The provision is effective for contributions for taxable
years beginning after December 31, 2004.
B. Improvements in Portability and Distribution Provisions
1. Purchase of permissive service credit (sec. 411 of the bill and
secs. 403(b)(13), 415(n)(3), and 457(e)(17) of the Code)
PRESENT LAW
In general
Present law imposes limits on contributions and benefits
under qualified plans.\80\ The limits on contributions and
benefits under qualified plans are based on the type of plan.
Under a defined benefit plan, the maximum annual benefit
payable at retirement is generally the lesser of (1) a certain
dollar amount ($165,000 for 2004) or (2) 100 percent of the
participant's average compensation for his or her high three
years.
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\80\ Sec. 415.
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A qualified retirement plan maintained by a State or local
government employer may provide that a participant may make
after-tax employee contributions in order to purchase
permissive service credit, subject to certain limits.\81\
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\81\ Sec. 415(n)(3).
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In the case of any repayment of contributions and earnings
to a governmental plan with respect to an amount previously
refunded upon a forfeiture of service credit under the plan (or
another plan maintained by a State or local government employer
within the same State), any such repayment is not taken into
account for purposes of the section 415 limits on contributions
and benefits. Also, service credit obtained as a result of such
a repayment is not considered permissive service credit for
purposes of the section 415 limits.
Permissive service credit
Definition of permissive service credit
Permissive service credit means credit for a period of
service recognized by the governmental plan which the
participant has not received under the plan and which the
employee receives only if the employee voluntarily contributes
to the plan an amount (as determined by the plan) that does not
exceed the amount necessary to fund the benefit attributable to
the period of service and that is in addition to the regular
employee contributions, if any, under the plan.
The IRS has ruled that credit is not permissive service
credit where it is purchased to provide enhanced retirement
benefits for a period of service already credited under the
plan, as the enhanced benefit is treated as credit for service
already received.\82\
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\82\ Priv. Ltr. Rul. 200229051 (April 26, 2002).
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Nonqualified service
Service credit is not permissive service credit if more
than five years of permissive service credit is purchased for
nonqualified service or if nonqualified service is taken into
account for an employee who has less than five years of
participation under the plan. Nonqualified service is service
other than service (1) as a Federal, State or local government
employee, (2) as an employee of an association representing
Federal, State or local government employees, (3) as an
employee of an educational institution which provides
elementary or secondary education, as determined under State
law, or (4) for military service. Service under (1), (2) and
(3) is nonqualified service if it enables a participant to
receive a retirement benefit for the same service under more
than one plan.
Trustee-to-trustee transfers to purchase permissive service
credit
Under EGTRRA, a participant is not required to include in
gross income a direct trustee-to-trustee transfer to a
governmental defined benefit plan from a section 403(b) annuity
or a section 457 plan if the transferred amount is used (1) to
purchase permissive service credit under the plan, or (2) to
repay contributions and earnings with respect to an amount
previously refunded under a forfeiture of service credit under
the plan (or another plan maintained by a State or local
government employer within the same State).\83\
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\83\ Secs. 403(b)(13) and 457(e)(17).
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REASONS FOR CHANGE
The Committee believes that allowing employees to use their
section 403(b) annuity and governmental section 457 plan
benefits to purchase permissive service credits or make
repayments with respect to forfeitures of service credit
results in more significant retirement benefits for employees
who would not otherwise be able to afford such credits or
repayments. The Committee believes that it is appropriate to
modify the provisions regarding such transfers in order to
facilitate such purchases or repayments. The Committee also
believes that it is appropriate to expand the definition of
permissive service credit and to allow participants to purchase
credit for other periods deemed appropriate by the public
retirement systems.
EXPLANATION OF PROVISION
Permissive service credit
The provision modifies the definition of permissive service
credit by providing that permissive service credit means
service credit which relates to benefits to which the
participant is not otherwise entitled under such governmental
plan, rather than service credit which such participant has not
received under the plan. Credit qualifies as permissive service
credit if it is purchased to provide an increased benefit for a
period of service already credited under the plan (e.g., if a
lower level of benefit is converted to a higher benefit level
otherwise offered under the same plan) as long as it relates to
benefits to which the participant is not otherwise entitled.
The provision allows participants to purchase credit for
periods regardless of whether service is performed, subject to
the limits on nonqualified service.
Under the provision, service as an employee of an
educational organization providing elementary or secondary
education can be determined under the law of the jurisdiction
in which the service was performed. Thus, for example,
permissive service credit can be granted for time spent
teaching outside of the United States without being considered
nonqualified service credit.
Trustee-to-trustee transfers to purchase permissive service credit
The provision provides that the limits regarding
nonqualified service are not applicable in determining whether
a trustee-to-trustee transfer from a section 403(b) annuity or
a section 457 plan to a governmental defined benefit plan is
for the purchase of permissive service credit. Thus, failure of
the transferee plan to satisfy the limits does not cause the
transferred amounts to be included in the participant's income.
As under present law, the transferee plan must satisfy the
limits in providing permissive service credit as a result of
the transfer.
The provision provides that trustee-to-trustee transfers
under sections 457(e)(17) and 403(b)(13) may be made regardless
of whether the transfer is made between plans maintained by the
same employer. The provision also provides that amounts
transferred from a section 403(b) annuity or a section 457 plan
to a governmental defined benefit plan to purchase permissive
service credit are subject to the distribution rules applicable
under the Internal Revenue Code to the defined benefit plan.
EFFECTIVE DATE
The provision is generally effective as if included in the
amendments made by section 1526(a) of the Taxpayer Relief Act
of 1997, except that the provision regarding trustee-to-trustee
transfers is effective as if included in the amendments made by
section 647 of the Economic Growth and Tax Relief
Reconciliation Act of 2001.
2. Rollover of after-tax amounts (sec. 412 of the bill and sec.
402(c)(2) of the Code)
PRESENT LAW
Employee after-tax contributions may be rolled over from a
tax-qualified retirement plan into another tax-qualified
retirement plan, if the plan to which the rollover is made is a
defined contribution plan, the rollover is accomplished through
a direct rollover, and the plan to which the rollover is made
provides for separate accounting for such contributions (and
earnings thereon). After-tax contributions can also be rolled
over from a tax-sheltered annuity (a ``section 403(b)
annuity'') to another tax-sheltered annuity if the rollover is
a direct rollover, and the annuity to which the rollover is
made provides for separate accounting for such contributions
(and earnings thereon). After-tax contributions may also be
rolled over to an IRA. If the rollover is to an IRA, the
rollover need not be a direct rollover and the IRA owner has
the responsibility to keep track of the amount of after-tax
contributions.\84\
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\84\ Sec. 402(c)(2); IRS Notice 2002-3, 2002-2 I.R.B. 289.
---------------------------------------------------------------------------
REASONS FOR CHANGE
Under present law, tax-sheltered annuities may provide for
after-tax contributions, but are not permitted to receive
rollovers of after-tax contributions from qualified retirement
plans. Under present law, after-tax contributions cannot be
rolled over into a defined benefit plan. The Committee wishes
to expand opportunities for portability with respect to after-
tax contributions.
EXPLANATION OF PROVISION
The provision allows after-tax contributions to be rolled
over from a qualified retirement plan to another qualified
retirement plan (either a defined contribution or a defined
benefit plan) or to a tax-sheltered annuity. As under present
law, the rollover must be a direct rollover, and the plan to
which the rollover is made must separately account for after-
tax contributions (and earnings thereon).
EFFECTIVE DATE
The provision is effective for taxable years beginning
after December 31, 2004.
3. Application of minimum distribution rules to governmental plans
(sec. 413 of the bill)
PRESENT LAW
Minimum distribution rules apply to tax-favored retirement
arrangements, including governmental plans. In general, under
these rules, distribution of minimum benefits must begin no
later than the required beginning date. Minimum distribution
rules also apply to benefits payable with respect to a plan
participant who has died. Failure to comply with the minimum
distribution rules results in an excise tax imposed on the plan
participant equal to 50 percent of the required minimum
distribution not distributed for the year. The excise tax may
be waived in certain cases.
In the case of distributions prior to the death of the plan
participant, the minimum distribution rules are satisfied if
either (1) the participant's entire interest in the plan is
distributed by the required beginning date, or (2) the
participant's interest in the plan is to be distributed (in
accordance with regulations) beginning not later than the
required beginning date, over a permissible period. The
permissible periods are (1) the life of the participant, (2)
the lives of the participant and a designated beneficiary, (3)
the life expectancy of the participant, or (4) the joint life
and last survivor expectancy of the participant and a
designated beneficiary. In calculating minimum required
distributions from account-type arrangements (e.g., a defined
contribution plan or an individual retirement arrangement),
life expectancies of the participant and the participant's
spouse generally may be recomputed annually.
The required beginning date generally is April 1 of the
calendar year following the later of (1) the calendar year in
which the participant attains age 70\1/2\ or (2) the calendar
year in which the participant retires.
The minimum distribution rules also apply to distributions
to beneficiaries of deceased participants. In general, if the
participant dies after minimum distributions have begun,
theremaining interest must be distributed at least as rapidly as under
the minimum distribution method being used as of the date of death. If
the participant dies before minimum distributions have begun, then the
entire remaining interest must generally be distributed within five
years of the participant's death. The five-year rule does not apply if
distributions begin within one year of the participant's death and are
payable over the life of a designated beneficiary or over the life
expectancy of a designated beneficiary. A surviving spouse beneficiary
is not required to begin distributions until the date the deceased
participant would have attained age 70\1/2\. In addition, if the
surviving spouse makes a rollover from the plan into a plan or IRA of
his or her own, the minimum distribution rules apply separately to the
surviving spouse.
REASONS FOR CHANGE
The Committee believes that governmental plans should be
provided greater flexibility in complying with the minimum
distribution requirements to accommodate plan designs commonly
used by governmental plans.
EXPLANATION OF PROVISION
The provision directs the Secretary of the Treasury to
issue regulations under which a governmental plan is treated as
complying with the minimum distribution requirements, for all
years to which such requirements apply, if the plan complies
with a reasonable, good faith interpretation of the statutory
requirements. It is intended that the regulations apply for
periods before the date of enactment.
EFFECTIVE DATE
The provision is effective on the date of enactment.
4. Waiver of 10-percent early withdrawal tax on certain distributions
from pension plans for public safety employees (sec. 414 of the
bill and sec. 72(t) of the Code)
PRESENT LAW
Under present law, a taxpayer who receives a distribution
from a qualified retirement plan prior to age 59\1/2\, death,
or disability generally is subject to a 10-percent early
withdrawal tax on the amount includible in income, unless an
exception to the tax applies. Among other exceptions, the early
distribution tax does not apply to distributions made to an
employee who separates from service after age 55, or to
distributions that are part of a series of substantially equal
periodic payments made for the life (or life expectancy) of the
employee or the joint lives (or life expectancies) of the
employee and his or her beneficiary.
REASONS FOR CHANGE
The Committee recognizes that public safety employees often
retire earlier than workers in other professions. The Committee
believes that public safety employees who separate from service
after age 50 should be permitted to receive distributions from
defined benefit pension plans without the imposition of the
early withdrawal tax.
EXPLANATION OF PROVISION
Under the provision, the 10-percent early withdrawal tax
does not apply to distributions from a governmental defined
benefit pension plan to a qualified public safety employee who
separates from service after age 50. A qualified public safety
employee is an employee of a State or political subdivision of
a State if the employee provides police protection,
firefighting services, or emergency medical services for any
area within the jurisdiction of such State or political
subdivision.
EFFECTIVE DATE
The provision is effective for distributions made after the
date of enactment.
5. Rollovers by nonspouse beneficiaries of certain retirement plan
distributions (sec. 415 of the bill and and secs. 402,
403(a)(4), 403(b)(8), and 457(e)(16) of the Code)
PRESENT LAW
Tax-free rollovers
Under present law, a distribution from a qualified
retirement plan, a tax-sheltered annuity ``section 403(b)
annuity''), an eligible deferred compensation plan of a State
or local government employer (a ``governmental section 457
plan''), or an individual retirement arrangement (an ``IRA'')
generally is included in income for the year distributed.
However, eligible rollover distributions may be rolled over tax
free within 60 days to another plan, annuity, or IRA.\85\
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\85\ The IRS has the authority to waive the 60-day requirement if
failure to waive the requirement would be against equity or good
conscience, including cases of casualty, disaster, or other events
beyond the reasonable control of the individual. Sec. 402(c)(3)(B).
---------------------------------------------------------------------------
In general, an eligible rollover distribution includes any
distribution to the plan participant or IRA owner other than
certain periodic distributions, minimum required distributions,
and distributions made on account of hardship.\86\
Distributions to a participant from a qualified retirement
plan, a tax-sheltered annuity, or a governmental section 457
plan generally can be rolled over to any of such plans or an
IRA.\87\ Similarly, distributions from an IRA to the IRA owner
generally are permitted to be rolled over into a qualified
retirement plan, a tax-sheltered annuity, a governmental
section 457 plan, or another IRA.
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\86\ Sec. 402(c)(4). Certain other distributions also are not
eligible rollover distributions, e.g., corrective distributions of
elective deferrals in excess of the elective deferral limits and loans
that are treated as deemed distributions.
\87\ Some restrictions or special rules may apply to certain
distributions. For example, after-tax amounts distributed from a plan
can be rolled over only to a plan of the same type or to an IRA.
---------------------------------------------------------------------------
Similar rollovers are permitted in the case of a
distribution to the surviving spouse of the plan participant or
IRA owner, but not to other persons.
If an individual inherits an IRA from the individual's
deceased spouse, the IRA may be treated as the IRA of the
surviving spouse. This treatment does not apply to IRAs
inherited from someone other than the deceased spouse. In such
cases, the IRA is not treated as the IRA of the beneficiary.
Thus, for example, the beneficiary may not make contributions
to the IRA and cannot roll over any amounts out of the
inherited IRA. Like the original IRA owner, no amount is
generally included in income until distributions are made from
the IRA. Distributions from the inherited IRA must be made
under the rules that apply to distributions to beneficiaries,
as described below.
Minimum distribution rules
Minimum distribution rules apply to tax-favored retirement
arrangements. In the case of distributions prior to the death
of the participant, distributions generally must begin by the
April 1 of the calendar year following the later of the
calendar year in which the participant (1) attains age 70\1/2\
or (2) retires.\88\ The minimum distribution rules also apply
to distributions following the death of the participant. If
minimum distributions have begun prior to the participant's
death, the remaining interest generally must be distributed at
least as rapidly as under the minimum distribution method being
used prior to the date of death. If the participant dies before
minimum distributions have begun, then either (1) the entire
remaining interest must be distributed within five years of the
death, or (2) distributions must begin within one year of the
death over the life (or life expectancy) of the designated
beneficiary. A beneficiary who is the surviving spouse of the
participant is not required to begin distributions until the
date the deceased participant would have attained age 70\1/2\.
In addition, if the surviving spouse makes a rollover from the
plan into a plan or IRA of his or her own, the minimum
distribution rules apply separately to the surviving spouse.
---------------------------------------------------------------------------
\88\ In the case of five-percent owners and distributions from an
IRA, distributions must begin by April 1 of the calendar year following
the year in which the individual attains age 70\1/2\.
---------------------------------------------------------------------------
REASONS FOR CHANGE
The Committee understands that, in practice, many plans
provide that distributions to a beneficiary who is not the
surviving spouse of the participant are paid out soon after the
death of participant in a lump sum, even though the minimum
distribution rules would permit a longer payout period. The
Committee understands that many beneficiaries would like to
avoid the adverse tax consequences of an immediate lump sum, as
well as take advantage of the opportunity to receive periodic
payments for life or over the beneficiary's lifetime. The
Committee wishes to provide beneficiaries with additional
flexibility regarding timing of distributions, consistent with
the minimum distribution rules applicable to nonspouse
beneficiaries. To accomplish this result, the Committee bill
allows nonspouse beneficiaries to roll over benefits received
after the death of the participant to an IRA and to receive
distributions in a manner consistent with the minimum
distribution rules for nonspouse beneficiaries.
EXPLANATION OF PROVISION
The provision provides that benefits of a beneficiary other
than a surviving spouse may be transferred directly to an IRA.
The IRA is treated as an inherited IRA of the nonspouse
beneficiary. Thus, for example, distributions from the
inherited IRA are subject to the distribution rules applicable
to beneficiaries. The provision applies to amounts payable to a
beneficiary under a qualified retirement plan, governmental
section 457 plan, or a tax-sheltered annuity. To the extent
provided by the Secretary, the provision applies to benefits
payable to a trust maintained for a designated beneficiary to
the same extent it applies to the beneficiary.
EFFECTIVE DATE
The provision is effective for distributions made after
December 31, 2004.
6. Faster vesting of employer nonelective contributions (sec. 416 of
the bill, sec. 411 of the Code, and sec. 203 of ERISA)
PRESENT LAW
Under present law, in general, a plan is not a qualified
plan unless a participant's employer-provided benefit vests at
least as rapidly as under one of two alternative minimum
vesting schedules. A plan satisfies the first schedule if a
participant acquires a nonforfeitable right to 100 percent of
the participant's accrued benefit derived from employer
contributions upon the completion of five years of service. A
plan satisfies the second schedule if a participant has a
nonforfeitable right to at least 20 percent of the
participant's accrued benefit derived from employer
contributions after three years of service, 40 percent after
four years of service, 60 percent after five years of service,
80 percent after six years of service, and 100 percent after
seven years of service.\89\
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\89\ The minimum vesting requirements are also contained in Title I
of the Employee Retirement Income Security Act of 1974 (``ERISA'').
---------------------------------------------------------------------------
Faster vesting schedules apply to employer matching
contributions. Employer matching contributions are required to
vest at least as rapidly as under one of the following two
alternative minimum vesting schedules. A plan satisfies the
first schedule if a participant acquires a nonforfeitable right
to 100 percent of employer matching contributions upon the
completion of three years of service. A plan satisfies the
second schedule if a participant has a nonforfeitable right to
20 percent of employer matching contributions for each year of
service beginning with the participant's second year of service
and ending with 100 percent after six years of service.
REASONS FOR CHANGE
For many employees, a defined contribution plan is the only
type of retirement plan offered by their employer. Providing
faster vesting for all employer contributions to such plans
will enable shorter-service employees to accumulate greater
retirement savings.
In addition, providing the same vesting rule for all
employer contributions to defined contribution plans will
provide simplification.
EXPLANATION OF PROVISION
The provision applies the present-law vesting schedule for
matching contributions to all employer contributions to defined
contribution plans.
EFFECTIVE DATE
The provision is effective for contributions (including
allocations of forfeitures) for plan years beginning after
December 31, 2004, with a delayed effective date for plans
maintained pursuant to a collective bargaining agreement. The
provision does not apply to any employee until the employee has
an hour of service after the effective date. In applying the
new vesting schedule, service before the effective date is
taken into account.
7. Allow direct rollovers from retirement plans to Roth IRAs (sec. 417
of the bill and sec. 408A(e) of the Code)
PRESENT LAW
IRAs in general
There are two general types of individual retirement
arrangements (``IRAs''): traditional IRAs, to which both
deductible and nondeductible contributions may be made, and
Roth IRAs.
Traditional IRAs
An individual may make deductible contributions to an IRA
up to the lesser of a dollar limit (generally $3,000 for 2004)
\90\ or the individual's compensation if neither the individual
nor the individual's spouse is an active participant in an
employer-sponsored retirement plan.\91\ If the individual (or
the individual's spouse) is an active participant in an
employer-sponsored retirement plan, the deduction limit is
phased out for taxpayers with adjusted gross income (``AGI'')
over certain levels for the taxable year. A different, higher,
income phaseout applies in the case of an individual who is not
an active participant in an employer sponsored plan but whose
spouse is.
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\90\ The dollar limit is scheduled to increase until it is $5,000
beginning in 2008-2010. Individuals age 50 and older may make
additional, catch-up contributions.
\91\ In the case of a married couple, deductible IRA contributions
of up to the dollar limit can be made for each spouse (including, for
example, a homemaker who does not work outside the home), if the
combined compensation of both spouses is at least equal to the
contributed amount.
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To the extent an individual cannot or does not make
deductible contributions to an IRA or contributions to a Roth
IRA, the individual may make nondeductible contributions to a
traditional IRA.
Amounts held in a traditional IRA are includible in income
when withdrawn (except to the extent the withdrawal is a return
of nondeductible contributions). Includible amounts withdrawn
prior to attainment of age 59\1/2\ are subject to an additional
10-percent early withdrawal tax, unless the withdrawal is due
to death or disability, is made in the form of certain periodic
payments, or is used for certain specified purposes.
Roth IRAs
Individuals with AGI below certain levels may make
nondeductible contributions to a Roth IRA. The maximum annual
contributions that can be made to all of an individual's IRAs
(both traditional and Roth) cannot exceed the maximum
deductible IRA contribution limit. The maximum annual
contribution that can be made to a Roth IRA is phased out for
taxpayers with income above certain levels.
Amounts held in a Roth IRA that are withdrawn as a
qualified distribution are not includible in income, or subject
to the additional 10-percent tax on early withdrawals. A
qualified distribution is a distribution that (1) is made after
the five-taxable year period beginning with the first taxable
year for which the individual made a contribution to a Roth
IRA, and (2) which is made after attainment of age 59\1/2\, on
account of death or disability, or is made for first-time
homebuyer expenses of up to $10,000.
Distributions from a Roth IRA that are not qualified
distributions are includible in income to the extent
attributable to earnings, and subject to the 10-percent early
withdrawal tax (unless an exception applies). The same
exceptions to the early withdrawal tax that apply to IRAs apply
to Roth IRAs.
Rollover contributions
If certain requirements are satisfied, a participant in a
tax-qualified retirement plan, a tax-sheltered annuity (sec.
403(b)), or a governmental section 457 plan may roll over
distributions from the plan or annuity into a traditional IRA.
Distributions from such plans may not be rolled over into a
Roth IRA.
Taxpayers with modified AGI of $100,000 or less generally
may roll over amounts in a traditional IRA into a Roth IRA. The
amount rolled over is includible in income as if a withdrawal
had been made, except that the 10-percent early withdrawal tax
does not apply. Married taxpayers who file separate returns
cannot roll over amounts in a traditional IRA into a Roth IRA.
Amounts that have been distributed from a tax-qualified
retirement plan, a tax-sheltered annuity, or a governmental
section 457 plan may be rolled over into a traditional IRA, and
then rolled over from the traditional IRA into a Roth IRA.
REASONS FOR CHANGE
Under present law if an individual wishes to roll over
amounts from a qualified retirement plan or similar arrangement
to a Roth IRA, they may do so, but only by first making a
rollover into a traditional IRA and then converting the amounts
in the traditional IRA into a Roth IRA. The Committee believes
it unnecessary to impose such complications on rollovers from
qualified retirement plans to Roth IRAs.
EXPLANATION OF PROVISION
The provision allows distributions from tax-qualified
retirement plans, tax-sheltered annuities, and governmental 457
plans to be rolled over directly from such plan into a Roth
IRA, subject to the present law rules that apply to rollovers
from a traditional IRA into a Roth IRA. For example, a rollover
from a tax-qualified retirement plan into a Roth IRA is
includible in gross income (except to the extent it represents
a return of after-tax contributions), and the 10-percent early
distribution tax does not apply. Similarly, an individual with
AGI of $100,000 or more could not roll over amounts from a tax-
qualified retirement plan directly into a Roth IRA.
EFFECTIVE DATE
The provision is effective for distributions made after
December 31, 2004.
8. Elimination of higher early withdrawal tax on certain SIMPLE plan
distributions (sec. 418 of the bill and sec. 72(t) of the Code)
PRESENT LAW
SIMPLE plans
Under present law, certain small businesses can establish a
simplified retirement plan called the savings incentive match
plan for employees (``SIMPLE'') retirement plan. SIMPLE plans
can be adopted by employers: (1) that employ 100 or fewer
employees who received at least $5,000 in compensation during
the preceding year; and (2) that do not maintain another
employer-sponsored retirement plan. A SIMPLE plan can be either
an individual retirement arrangement (an ``IRA'') \92\ for each
employee or part of a qualified cash or deferred arrangement (a
``section 401(k) plan'').\93\ The rules applicable to SIMPLE
IRAs and SIMPLE section 401(k) plans are similar, but not
identical.
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\92\ A SIMPLE IRA may not be in the form of a Roth IRA. References
herein to IRAs do not refer to Roth IRAs.
\93\ Because State or local governments generally are not permitted
to maintain section 401(k) plans, they also generally are not permitted
to maintain SIMPLE section 401(k) plans. However, a State or local
governments with a pre-May 6, 1986, grandfathered section 401(k) plan
may adopt a SIMPLE section 401(k) plan.
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If established in IRA form, a SIMPLE plan is not subject to
the nondiscrimination rules generally applicable to qualified
retirement plans (including the top-heavy rules) and simplified
reporting requirements apply. If established as part of a
section 401(k) plan, the SIMPLE does not have to satisfy the
special nondiscrimination tests applicable to section 401(k)
plans and is not subject to the top-heavy rules. The other
qualified retirement plan rules apply to SIMPLE section 401(k)
plans.
Elective deferrals under a section 401(k) plan generally
may not be distributable before the occurrence of certain
specified events, such as severance of employment, death,
disability, attainment of age 59\1/2\, or financial hardship.
This restriction on distributions applies to elective deferrals
made under a SIMPLE section 401(k) plan, but not elective
deferrals made under a SIMPLE IRA.
Early withdrawal tax
Taxable distributions made from an IRA or from certain
employer-sponsored retirement plans (including a section 401(k)
plan) before age 59\1/2\, death, or disability generally are
subject to an additional 10-percent income tax. Early
withdrawals from a SIMPLE plan generally are subject to the
additional 10-percent tax. However, in the case of a SIMPLE
IRA, early withdrawals during the two-year period beginning on
the date the employee first participated in the SIMPLE IRA are
subject to an additional 25-percent tax.
REASONS FOR CHANGE
The Committee believes that early withdrawals from SIMPLE
IRAs should be subject to the same additional tax as other
early withdrawals.
EXPLANATION OF PROVISION
The provision eliminates the 25-percent tax on early
withdrawals from a SIMPLE IRA during the two-year period
beginning on the date the employee first participated in the
SIMPLE IRA. Thus, such withdrawals are subject to the 10-
percent early withdrawal tax.
EFFECTIVE DATE
The provision is effective for years beginning after
December 31, 2004.
9. SIMPLE plan portability (sec. 419 of the bill and secs. 402(c) and
408(d) of the Code)
PRESENT LAW
Under present law, certain small businesses can establish a
simplified retirement plan called the savings incentive match
plan for employees (``SIMPLE'') retirement plan. SIMPLE plans
can be adopted by employers: (1) that employ 100 or fewer
employees who received at least $5,000 in compensation during
the preceding year; and (2) that do not maintain another
employer-sponsored retirement plan. A SIMPLE plan can be either
an individual retirementarrangement (an ``IRA'') \94\ for each
employee or part of a qualified cash or deferred arrangement (a
``section 401(k) plan'').\95\ The rules applicable to SIMPLE IRAs and
SIMPLE section 401(k) plans are similar, but not identical.
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\94\ A SIMPLE IRA may not be in the form of a Roth IRA. References
herein to IRAs do not refer to Roth IRAs.
\95\ Because State or local governments generally are not permitted
to maintain seciton 401(k) plans, they also generally are not permitted
to maintain SIMPLE section 401(k) plans. However, a State or local
government with a pre-May 6, 1986, grandfathered section 401(k) plan
may adopt a SIMPLE section 401(k) plan.
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If established in IRA form, a SIMPLE plan is not subject to
the nondiscrimination rules generally applicable to qualified
retirement plans (including the top-heavy rules) and simplified
reporting requirements apply. If established as part of a
section 401(k) plan, the SIMPLE does not have to satisfy the
special nondiscrimination tests applicable to section 401(k)
plans and is not subject to the top-heavy rules. The other
qualified retirement plan rules apply to SIMPLE section 401(k)
plans.
Distributions from employer-sponsored retirement plans and
IRAs (including SIMPLE plans) are generally includible in gross
income, except to the extent the amount distributed represents
a return of after-tax contributions (i.e., basis). If certain
requirements are satisfied, distributions from a tax-favored
retirement arrangement (i.e., a qualified retirement plan, a
tax-sheltered annuity, a governmental section 457 plan, or an
IRA) may generally be rolled over on a nontaxable basis to
another tax-favored retirement arrangement. However, a
distribution from a SIMPLE IRA during the two-year period
beginning on the date the employee first participated in the
SIMPLE IRA may be rolled over only to another SIMPLE IRA.
REASONS FOR CHANGE
The Committee believes that allowing rollovers between
SIMPLE IRAs and other tax-favored retirement arrangements will
help preserve retirement savings.
EXPLANATION OF PROVISION
The provision allows distributions from a SIMPLE IRA to be
rolled over to another tax-favored retirement arrangement
(i.e., an IRA, a qualified retirement plan, a tax-sheltered
annuity, or a governmental section 457 plan) and distributions
from another tax-favored retirement arrangement to be rollover
over to a SIMPLE IRA.
EFFECTIVE DATE
The provision is effective for years beginning after
December 31, 2004.
10. Eligibility for participation in eligible deferred compensation
plans (sec. 420 of the bill)
PRESENT LAW
A section 457 plan is an eligible deferred compensation
plan of a State or local government or tax-exempt employer that
meets certain requirements. In some cases, different rules
apply under section 457 to governmental plans and plans of tax-
exempt employers.
Amounts deferred under an eligible deferred compensation
plan of a non-governmental tax-exempt organization are
includible in gross income for the year in which amounts are
paid or made available. Under present law, if the amount
payable to a participant does not exceed $5,000, a plan may
allow a distribution up to $5,000 without such amount being
treated as made available if the distribution can be made only
if no amount has been deferred under the plan by the
participant during the two-year period ending on the date of
the distribution and there has been no prior distribution under
the plan. Prior to the Small Business Job Protection Act of
1996, under former section 457(e)(9), benefits were not treated
as made available because a participant could elect to receive
a lump sum payable after separation from service and within 60
days of the election if (1) the total amount payable under the
plan did not exceed $3,500 and (2) no additional amounts could
be deferred under the plan.
REASONS FOR CHANGE
The Committee believes that individuals should not be
precluded from participating in an eligible deferred
compensation plan by reason of certain prior distributions.
EXPLANATION OF PROVISION
Under the provision, an individual is not precluded from
participating in an eligible deferred compensation plan by
reason of having received a distribution under section
457(e)(9) as in effect before the Small Business Job Protection
Act of 1996.
EFFECTIVE DATE
The provision is effective on the date of enactment.
11. Benefit transfers to the PBGC (sec. 421 of the bill, sec.
401(a)(31) of the Code, and sec. 4050 of ERISA)
PRESENT LAW
Involuntary distributions and automatic rollovers
If a qualified retirement plan participant ceases to be
employed by the employer that maintains the plan, the plan may
distribute the participant's nonforfeitable accrued benefit
without the consent of the participant (an ``involuntary
distribution'') and, if applicable, theparticipant's spouse, if
the present value of the benefit does not exceed $5,000.\96\ Generally,
a participant may roll over an involuntary distribution from a
qualified plan to an individual retirement arrangement (an ``IRA'') or
to another qualified plan.
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\96\ The portion of a participant's benefit that is attributable to
amounts rolled over from another plan may be disregarded in determining
the present value of the participant's vested accrued benefit.
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In the case of an involuntary distribution that exceeds
$1,000 and that is an eligible rollover distribution from a
qualified retirement plan, the plan administrator must roll the
distribution over to an IRA (an ``automatic rollover'') in
certain cases.\97\ That is, the plan administrator must make a
direct trustee-to-trustee transfer of the distribution to an
IRA, unless the participant affirmatively elects to have the
distribution transferred to a different IRA or a qualified plan
or to receive it directly.
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\97\ Sec. 401(a)(31)(B). This provision was enacted by section 657
of EGTRRA and applies to distributions after the issuance of final
regulations by the Department of Labor providing safe harbos for
satisfying fiduciary requirements related to automatic rollovers.
Proposed regulations providing such a safe harbor were issued by the
Department of Labor, to be effective six months after the issuance of
final regulations. 69 Fed. Reg. 9900 (March 2, 2004). The provisions of
EGTRRA generally do not apply for years beginning after December 31,
2010.
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Before making a distribution that is eligible for rollover,
a plan administrator must provide the participant with a
written explanation of the ability to have the distribution
rolled over directly to an IRA or another qualified plan and
the related tax consequences. In the case of an automatic
rollover to an IRA, the written explanation provided by the
plan administrator is required to explain that an automatic
rollover will be made unless the participant elects otherwise.
The plan administrator is also required to notify the
participant in writing (as part of the general written
explanation or separately) that the distribution may be
transferred to another IRA.
Missing participant benefits
In the case of a defined benefit pension plan that is
subject to the plan termination insurance program under Title
IV of the Employee Retirement Income Security Act of 1974
(``ERISA''), is maintained by a single employer, and terminates
under a standard termination, the plan administrator generally
must purchase annuity contracts from a private insurer to
provide the benefits to which participants are entitled and
distribute the annuity contracts to the participants.
If the plan administrator of a terminating single employer
plan cannot locate a participant after a diligent search (a
``missing participant''), the plan administrator may satisfy
the distribution requirement only by purchasing an annuity from
an insurer or transferring the participant's designated benefit
to the Pension Benefit Guaranty Corporation (``PBGC''), which
holds the benefit of the missing participant as trustee until
the PBGC locates the missing participant and distributes the
benefit.\98\
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\98\ Secs. 4041(b)(3)(A) and 4050 of ERISA.
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The PBGC missing participant program is not available to
multiemployer plans or defined contribution plans and other
plans not covered by Title IV of ERISA.
Reasons for Change
The Committee believes that allowing plan administrators to
make automatic rollovers to the PBGC will facilitate automatic
rollovers and reduce administrative burdens while providing
adequate participant protections.
Explanation of Provision
The provision provides an alternative to the automatic
rollover to an IRA of an involuntary distribution that exceeds
$1,000. Under the provision, unless the participant elects to
have the distribution transferred to an IRA or a qualified
retirement plan or to receive it directly, the plan may provide
for the transfer of the distribution to the PBGC, instead of to
an IRA.\99\ The written explanation provided to the participant
by the plan administrator before the involuntary distribution
must explain that a transfer to the PBGC will be made unless
the participant elects otherwise.
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\99\ The provision applies to all automatic rollovers, not just
those for missing participants.
---------------------------------------------------------------------------
The provision extends the provisions relating to the PBGC
missing participant program to involuntary distributions that
are transferred to the PBGC. Benefits transferred to the PBGC
under the provision are to be distributed by the PBGC to the
participant upon application filed by the participant with the
PBGC in such form and manner as prescribed by the PBGC in
regulations. Benefits are to be distributed in a single sum
(plus interest) or in another form as specified in PBGC
regulations.
The transfer of an involuntary distribution to the PBGC is
treated as a transfer to an IRA (i.e., the amount transferred
is not included in the participant's income). An amount
distributed by the PBGC is generally treated as a distribution
from an IRA.
EFFECTIVE DATE
The provision is generally effective as if included in the
amendments made by section 657 of EGTRRA, i.e., after the
issuance of final regulations by the Department of Labor. The
extension of the PBGC missing participant program to
involuntary distributions that are transferred to the PBGC is
effective for distributions made after the issuance of final
regulations implementing such extension. The PBGC is directed
to issue such regulations not later than December 31, 2004.
C. Administrative Provisions
1. Improvement of Employee Plans Compliance Resolution System (sec. 431
of the bill)
PRESENT LAW
A retirement plan that is intended to be a tax-qualified
plan provides retirement benefits on a tax-favored basis if the
plan satisfies all of the requirements of section 401(a).
Similarly, an annuity that is intended to be a tax-sheltered
annuity provides retirement benefits on a tax-favored basis if
the program satisfies all of the requirements of section
403(b). Failure to satisfy all of the applicable requirements
of section 401(a) or section 403(b) may disqualify a plan or
annuity for the intended tax-favored treatment.
The Internal Revenue Service (``IRS'') has established the
Employee Plans Compliance Resolution System (``EPCRS''), which
is a comprehensive system of correction programs for sponsors
of retirement plans and annuities that are intended, but have
failed, to satisfy the requirements of section 401(a), section
403(a), section 403(b), section 408(k), or section 408(p) as
applicable.\100\ EPCRS permits employers to correct compliance
failures and continue to provide their employees with
retirement benefits on a tax-favored basis.
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\100\ Rev. Proc. 2003-44, 2003-25 I.R.B. 1051.
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The IRS has designed EPCRS to (1) encourage operational and
formal compliance, (2) promote voluntary and timely correction
of compliance failures, (3) provide sanctions for compliance
failures identified on audit that are reasonable in light of
the nature, extent, and severity of the violation, (4) provide
consistent and uniform administration of the correction
programs, and (5) permit employers to rely on the availability
of EPCRS in taking corrective actions to maintain the tax-
favored status of their retirement plans and annuities.
The basic elements of the programs that comprise EPCRS are
self-correction, voluntary correction with IRS approval, and
correction on audit. The Self-Correction Program (``SCP'')
generally permits a plan sponsor that has established
compliance practices and procedures to correct certain
insignificant failures at any time (including during an audit),
and certain significant failures within a 2-year period,
without payment of any fee or sanction. The Voluntary
Correction Program (``VCP'') permits an employer, at any time
before an audit, to pay a limited fee and receive IRS approval
of a correction. For a failure that is discovered on audit and
corrected, the Audit Closing Agreement Program (``Audit CAP'')
provides for a sanction that bears a reasonable relationship to
the nature, extent, and severity of the failure and that takes
into account the extent to which correction occurred before
audit.
The IRS has expressed its intent that EPCRS will be updated
and improved periodically in light of experience and comments
from those who use it.
REASONS FOR CHANGE
The Committee commends the IRS for the establishment of
EPCRS and agrees with the IRS that EPCRS should be updated and
improved periodically. The Committee believes that future
improvements should facilitate use of the compliance and
correction programs by small employers and expand the
flexibility of the programs.
EXPLANATION OF PROVISION
The provision clarifies that the Secretary has the full
authority to establish and implement EPCRS (or any successor
program) and any other employee plans correction policies,
including the authority to waive income, excise or other taxes
to ensure that any tax, penalty or sanction is not excessive
and bears a reasonable relationship to the nature, extent and
severity of the failure.
Under the provision, the Secretary of the Treasury is
directed to continue to update and improve EPCRS (or any
successor program), giving special attention to (1) increasing
the awareness and knowledge of small employers concerning the
availability and use of EPCRS, (2) taking into account special
concerns and circumstances that small employers face with
respect to compliance and correction of compliance failures,
(3) extending the duration of the self-correction period under
SCP for significant compliance failures, (4) expanding the
availability to correct insignificant compliance failures under
SCP during audit, and (5) assuring that any tax, penalty, or
sanction that is imposed by reason of a compliance failure is
not excessive and bears a reasonable relationship to the
nature, extent, and severity of the failure.
EFFECTIVE DATE
The provision is effective on the date of enactment.
2. Extension to all governmental plans of moratorium on application of
certain nondiscrimination rules (sec. 432 of the bill, sec.
1505 of the Taxpayer Relief Act of 1997, and secs. 401(a) and
401(k) of the Code)
PRESENT LAW
A qualified retirement plan maintained by a State or local
government is exempt from the requirements concerning
nondiscrimination (sec. 401(a)(4)) and minimum participation
(sec. 401(a)(26)). A qualified retirement plan maintained by a
State or local government is also treated as meeting the
participation and nondiscrimination requirements applicable to
a qualified cash or deferred arrangement (sec. 401(k)(3)).
Other governmental plans are subject to these
requirements.\101\
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\101\ The IRS has announced that governmental plans that are
subject to the nondiscrimination requirements are deemed to satisfy
such requirements pending the issuance of final regulations addressing
this issue. Notice 2003-6, 2003-3 I.R.B. 298; Notice 2001-46, 2001-2
C.B. 122.
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REASONS FOR CHANGE
The Committee believes that application of the
nondiscrimination and minimum participation rules to
governmental plans is unnecessary and inappropriate in light of
the unique circumstances under which such plans and
organizations operate. Further, the Committee believes that it
is appropriate to provide for consistent application of the
minimum coverage, nondiscrimination, and minimum participation
rules for governmental plans.
EXPLANATION OF PROVISION
The provision exempts all governmental plans (as defined in
sec. 414(d)) from the nondiscrimination and minimum
participation rules. The provision also treats all governmental
plans as meeting the participation and nondiscrimination
requirements applicable to a qualified cash or deferred
arrangement.
EFFECTIVE DATE
The provision is effective for plan years beginning after
December 31, 2004.
3. Notice and consent period regarding distributions (sec. 433 of the
bill, sec. 417(a) of the Code, and sec. 205(c) of ERISA)
PRESENT LAW
Notice and consent requirements apply to certain
distributions from qualified retirement plans. These
requirements relate to the content and timing of information
that a plan must provide to a participant prior to a
distribution, and to whether the plan must obtain the
participant's consent to the distribution. The nature and
extent of the notice and consent requirements applicable to a
distribution depend upon the value of the participant's vested
accrued benefit and whether the joint and survivor annuity
requirements (sec. 417) apply to the participant.
If the present value of the participant's vested accrued
benefit exceeds $5,000,\102\ the plan may not distribute the
participant's benefit without the written consent of the
participant. The participant's consent to a distribution is not
valid unless the participant has received from the plan a
notice that contains a written explanation of (1) the material
features and the relative values of the optional forms of
benefit available under the plan, (2) the participant's right,
if any, to have the distribution directly transferred to
another retirement plan or individual retirement arrangement
(``IRA''), and (3) the rules concerning the taxation of a
distribution. If the joint and survivor annuity requirements
are applicable, this notice also must contain a written
explanation of (1) the terms and conditions of the qualified
joint and survivor annuity (``QJSA''), (2) the participant's
right to make, and the effect of, an election to waive the
QJSA, (3) the rights of the participant's spouse with respect
to a participant's waiver of the QJSA, and (4) the right to
make, and the effect of, a revocation of a waiver of the QJSA.
The plan generally must provide this notice to the participant
no less than 30 and no more than 90 days before the date
distribution commences.
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\102\ The portion of a participant's benefit that is attributable
to amounts rolled over from another plan may be disregarded in
determining the present value of the participant's vested accrued
benefit.
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REASONS FOR CHANGE
The Committee understands that an employee is not always
able to evaluate distribution alternatives, select the most
appropriate alternative, and notify the plan of the selection
within a 90-day period. The Committee believes that requiring a
plan to furnish multiple distribution notices to an employee
who does not make a distribution election within 90 days is
administratively burdensome. In addition, the Committee
believes that participants who are entitled to defer
distributions should be informed of the impact of a decision
not to defer distribution on the taxation and accumulation of
their retirement benefits.
EXPLANATION OF PROVISION
Under the provision, a qualified retirement plan is
required to provide the applicable distribution notice no less
than 30 days and no more than 180 days before the date
distribution commences. The Secretary of the Treasury is
directed to modify the applicable regulations to reflect the
extension of the notice period to 180 days and to provide that
the description of a participant's right, if any, to defer
receipt of a distribution shall also describe the consequences
of failing to defer such receipt.
EFFECTIVE DATE
The provision and the modifications required to be made
under the provision apply to years beginning after December 31,
2004. In the case of a description of the consequences of a
participant's failure to defer receipt of a distribution that
is made before the date 90 days after the date on which the
Secretary of the Treasury makes modifications to the applicable
regulations, the plan administrator is required to make a
reasonable attempt to comply with the requirements of the
provision.
4. Pension plan reporting simplification (sec. 434 of the bill)
PRESENT LAW
A plan administrator of a pension, annuity, stock bonus,
profit-sharing or other funded plan of deferred compensation
generally must file with the Secretary of the Treasury an
annual return for each plan year containing certain information
with respect to the qualification, financial condition, and
operation of the plan. Title I of ERISA also may require the
plan administrator to file annual reports concerning the plan
with the Department of Labor and the Pension Benefit Guaranty
Corporation (``PBGC''). The plan administrator must use the
Form 5500 series as the format for the required annual
return.\103\ The Form 5500 series annual return/report, which
consists of a primary form and various schedules, includes the
information required to be filed with all three agencies. The
plan administrator satisfies the reporting requirement with
respect to each agency by filing the Form 5500 series annual
return/report with the Department of Labor, which forwards the
form to the Internal Revenue Service and the PBGC.
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\103\ Treas. Reg. sec. 301.6058-1(a).
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The Form 5500 series consists of 2 different forms: Form
5500 and Form 5500-EZ. Form 5500 is the more comprehensive of
the forms and requires the most detailed financial information.
The plan administrator of a ``one-participant plan'' generally
may file Form 5500-EZ, which consists of only one page. For
this purpose, a plan is a one-participant plan if: (1) the only
participants in the plan are the sole owner of a business that
maintains the plan (and such owner's spouse), or partners in a
partnership that maintains the plan (and such partners'
spouses); (2) the plan is not aggregated with another plan in
order to satisfy the minimum coverage requirements of section
410(b); (3) the plan does not provide benefits to anyone other
than the sole owner of the business (or the sole owner and
spouse) or the partners in the business (or the partners and
spouses); (4) the employer is not a member of a related group
of employers; and (5) the employer does not use the services of
leased employees. In addition, the plan administrator of a one-
participant plan is not required to file a return if the plan
does not have an accumulated funding deficiency and the total
value of the plan assets as of the end of the plan year and all
prior plan years beginning on or after January 1, 1994, does
not exceed $100,000.
With respect to a plan that does not satisfy the
eligibility requirements for Form 5500-EZ, the characteristics
and the size of the plan determine the amount of detailed
financial information that the plan administrator must provide
on Form 5500. If the plan has more than 100 participants at the
beginning of the plan year, the plan administrator generally
must provide more information.
REASONS FOR CHANGE
The Committee believes that simplification of the reporting
requirements applicable to plans of small employers will
encourage such employers to provide retirement benefits for
their employees.
EXPLANATION OF PROVISION
The Secretary of the Treasury and the Secretary of Labor
are directed to modify the annual return filing requirements
with respect to a one-participant plan to provide that if the
total value of the plan assets of such a plan as of the end of
the plan year does not exceed $250,000, the plan administrator
is not required to file a return. In addition, the provision
directs the Secretary of the Treasury and the Secretary of
Labor to provide simplified reporting requirements for plan
years beginning after December 31, 2004, for certain plans with
fewer than 25 employees.
EFFECTIVE DATE
The provision relating to one-participant retirement plans
is effective for plan years beginning on or after January 1,
2004. The provision relating to simplified reporting for plans
with fewer than 25 employees is effective on the date of
enactment.
5. Missing participants (sec. 435 of the bill and sec. 4050 of ERISA)
PRESENT LAW
In the case of a defined benefit pension plan that is
subject to the plan termination insurance program under Title
IV of the Employee Retirement Income Security Act of 1974
(``ERISA''), is maintained by a single employer, and terminates
under a standard termination, the plan administrator generally
must purchase annuity contracts from a private insurer to
provide the benefits to which participants are entitled and
distribute the annuity contracts to the participants.
If the plan administrator of a terminating single employer
plan cannot locate a participant after a diligent search (a
``missing participant''), the plan administrator may satisfy
the distribution requirement only by purchasing an annuity from
an insurer or transferring the participant's designated benefit
to the Pension Benefit Guaranty Corporation (``PBGC''), which
holds the benefit of the missing participant as trustee until
the PBGC locates the missing participant and distributes the
benefit.\104\
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\104\ Secs. 4041(b)(3)(A) and 4050 of ERISA.
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The PBGC missing participant program is not available to
multiemployer plans or defined contribution plans and other
plans not covered by Title IV of ERISA.
REASONS FOR CHANGE
The Committee recognizes that no statutory provision or
formal regulatory guidance exists concerning an appropriate
method of handling the benefits of missing participants in
terminated multiemployer plans or defined contribution plans
and other plans not subject to the PBGC termination insurance
program. Therefore, sponsors of these plans face uncertainty
with respect to the benefits of missing participants. The
Committee believes that it is appropriate to extend the
established PBGC missing participant program to these plans in
order to reduce uncertainty for plan sponsors and increase the
likelihood that missing participants will receive their
retirement benefits.
EXPLANATION OF PROVISION
The PBGC is directed to prescribe rules for terminating
multiemployer plans similar to the present-law missing
participant rules applicable to terminating single-employer
plans that are subject to Title IV of ERISA.
In addition, plan administrators of certain types of plans
not subject to the PBGC termination insurance program under
present law are permitted, but not required, to elect to
transfer missing participants' benefits to the PBGC upon plan
termination. Specifically, the provision extends the missing
participants program (in accordance with regulations) to
defined contribution plans, defined benefit pension plans that
have no more than 25 active participants and are maintained by
professional service employers, and the portion of defined
benefit pensionplans that provide benefits based upon the
separate accounts of participants and therefore are treated as defined
contribution plans under ERISA.
EFFECTIVE DATE
The provision is effective for distributions made after
final regulations implementing the provision are prescribed.
6. Reduced PBGC premiums for small and new plans (secs. 436 and 437 of
the bill and sec. 4006 of ERISA)
PRESENT LAW
Under present law, the Pension Benefit Guaranty Corporation
(``PBGC'') provides insurance protection for participants and
beneficiaries under certain defined benefit pension plans by
guaranteeing certain basic benefits under the plan in the event
the plan is terminated with insufficient assets to pay benefits
promised under the plan. The guaranteed benefits are funded in
part by premium payments from employers who sponsor defined
benefit pension plans. The amount of the required annual PBGC
premium for a single-employer plan is generally a flat rate
premium of $19 per participant and an additional variable-rate
premium based on a charge of $9 per $1,000 of unfunded vested
benefits. Unfunded vested benefits under a plan generally means
(1) the unfunded current liability for vested benefits under
the plan, over (2) the value of the plan's assets, reduced by
any credit balance in the funding standard account. No
variable-rate premium is imposed for a year if contributions to
the plan were at least equal to the full funding limit.
The PBGC guarantee is phased in ratably in the case of
plans that have been in effect for less than five years, and
with respect to benefit increases from a plan amendment that
was in effect for less than five years before termination of
the plan.
REASONS FOR CHANGE
The Committee believes that reducing the PBGC premiums for
new plans and plans of small employers will help encourage the
establishment of defined benefit pension plans, particularly by
small employers.
EXPLANATION OF PROVISION
Reduced flat-rate premiums for new plans of small employers
Under the provision, for the first five plan years of a new
single-employer plan of a small employer, the flat-rate PBGC
premium is $5 per plan participant.
A small employer would be a contributing sponsor that, on
the first day of the plan year, has 100 or fewer employees. For
this purpose, all employees of the members of the controlled
group of the contributing sponsor are to be taken into account.
In the case of a plan to which more than one unrelated
contributing sponsor contributes, employees of all contributing
sponsors (and their controlled group members) are to be taken
into account in determining whether the plan was a plan of a
small employer.
A new plan means a defined benefit pension plan maintained
by a contributing sponsor if, during the 36-month period ending
on the date of adoption of the plan, such contributing sponsor
(or controlled group member or a predecessor of either) has not
established or maintained a plan subject to PBGC coverage with
respect to which benefits were accrued for substantially the
same employees as in the new plan.
Reduced variable-rate PBGC premium for new plans
The provision provides that the variable-rate premium is
phased in for new defined benefit pension plans over a six-year
period starting with the plan's first plan year. The amount of
the variable-rate premium is a percentage of the variable
premium otherwise due, as follows: zero percent of the
otherwise applicable variable-rate premium in the first plan
year; 20 percent in the second plan year; 40 percent in the
third plan year; 60 percent in the fourth plan year; 80 percent
in the fifth plan year; and 100 percent in the sixth plan year
(and thereafter).
A new defined benefit pension plan is defined as described
above under the flat-rate premium provision of the provision
relating to new small employer plans.
Reduced variable-rate PBGC premium for small plans
In the case of a plan of a small employer, the variable-
rate premium is no more than $5 multiplied by the number of
plan participants in the plan at the end of the preceding plan
year. For purposes of the provision, a small employer is a
contributing sponsor that, on the first day of the plan year,
has 25 or fewer employees. For this purpose, all employees of
the members of the controlled group of the contributing sponsor
are to be taken into account. In the case of a plan to which
more than one unrelated contributing sponsor contributed,
employees of all contributing sponsors (and their controlled
group members) are to be taken into account in determining
whether the plan was a plan of a small employer.
EFFECTIVE DATE
The reduction of the flat-rate premium for new plans of
small employers and the reduction of the variable-rate premium
for new plans apply to plans first effective after December 31,
2004. The reduction of the variable-rate premium for small
plans applies to plan years beginning after December 31, 2004.
7. Authorization for PBGC to pay interest on premium overpayment
refunds (sec. 438 of the bill and sec. 4007(b) of ERISA)
PRESENT LAW
The PBGC charges interest on underpayments of premiums, but
is not authorized to pay interest on overpayments.
REASONS FOR CHANGE
The Committee believes that an employer or other person who
overpays PBGC premiums should receive interest on a refund of
the overpayment.
EXPLANATION OF PROVISION
The provision allows the PBGC to pay interest on
overpayments made by premium payors. Interest paid on
overpayments is to be calculated at the same rate and in the
same manner as interest charged on premium underpayments.
EFFECTIVE DATE
The provision is effective with respect to interest
accruing for periods beginning not earlier than the date of
enactment.
8. Rules for substantial owner benefits in terminated plans (sec. 439
of the bill and secs. 4021, 4022, 4043, and 4044 of ERISA)
PRESENT LAW
Under present law, the Pension Benefit Guaranty Corporation
(``PBGC'') provides participants and beneficiaries in a defined
benefit pension plan with certain minimal guarantees as to the
receipt of benefits under the plan in case of plan termination.
The employer sponsoring the defined benefit pension plan is
required to pay premiums to the PBGC to provide insurance for
the guaranteed benefits. In general, the PBGC will guarantee
all basic benefits which are payable in periodic installments
for the life (or lives) of the participant and his or her
beneficiaries and are non-forfeitable at the time of plan
termination. The amount of the guaranteed benefit is subject to
certain limitations. One limitation is that the plan (or an
amendment to the plan which increases benefits) must be in
effect for 60 months before termination for the PBGC to
guarantee the full amount of basic benefits for a plan
participant, other than a substantial owner. In the case of a
substantial owner, the guaranteed basic benefit is phased in
over 30 years beginning with participation in the plan. A
substantial owner is one who owns, directly or indirectly, more
than 10 percent of the voting stock of a corporation or all the
stock of a corporation. Special rules restricting the amount of
benefit guaranteed and the allocation of assets also apply to
substantial owners.
REASONS FOR CHANGE
The Committee believes that the present-law rules
concerning limitations on guaranteed benefits for substantial
owners are overly complicated and restrictive and thus may
discourage some small business owners from establishing defined
benefit pension plans.
EXPLANATION OF PROVISION
The provision provides that the 60-month phase-in of
guaranteed benefits applies to a substantial owner with less
than 50 percent ownership interest. For a substantial owner
with a 50 percent or more ownership interest (``majority
owner''), the phase-in occurs over a 10-year period and depends
on the number of years the plan has been in effect. The
majority owner's guaranteed benefit is limited so that it
cannot be more than the amount phased in over 60 months for
other participants. The rules regarding allocation of assets
apply to substantial owners, other than majority owners, in the
same manner as other participants.
EFFECTIVE DATE
The provision is effective for plan terminations with
respect to which notices of intent to terminate are provided,
or for which proceedings for termination are instituted by the
PBGC, after December 31, 2004.
9. Voluntary early retirement incentive and employment retention plans
maintained by local educational agencies and other entities
(sec. 440 of the bill, secs. 457(e)(11) and 457(f) of the Code,
sec. 3(2)(B) of ERISA, and sec. 4(l)(1) of the ADEA)
PRESENT LAW
Eligible deferred compensation plans of State and local governments and
tax-exempt employers
A ``section 457 plan'' is an eligible deferred compensation
plan of a State or local government or tax-exempt employer that
meets certain requirements. For example, the amount that can be
deferred annually under section 457 cannot exceed a certain
dollar limit ($13,000 for 2004). Amounts deferred under a
section 457 plan are generally includible in gross income when
paid or made available (or, in the case of governmental section
457 plans, when paid). Subject to certain exceptions, amounts
deferred under a plan that does not comply with section 457 (an
``ineligible plan'') are includible in income when the amounts
are not subject to a substantial risk of forfeiture. Section
457 does not apply to any bona fide vacation leave, sick leave,
compensatory time, severance pay, disability pay, or death
benefit plan. Additionally, section 457 does not apply to
qualified retirement plans or qualified governmental excess
benefit plans that provide benefits in excess of those that are
provided under a qualified retirement plan maintained by the
governmental employer.
ERISA
ERISA provides rules governing the operation of most
employee benefit plans. The rules to which a plan is subject
depend on whether the plan is an employee welfare benefit plan
or an employee pension benefit plan. For example, employee
pension benefit plans are subject to reporting and disclosure
requirements, participation and vesting requirements, funding
requirements, and fiduciary provisions. Employee welfare
benefit plans are not subject to all of these requirements.
Governmental plans are exempt from ERISA.
Age Discrimination in Employment Act
The Age Discrimination in Employment Act (``ADEA'')
generally prohibits discrimination in employment because of
age. However, certain defined benefit pension plans may
lawfully provide payments that constitute the subsidized
portion of an early retirementbenefit or social security
supplements pursuant to ADEA \105\, and employers may lawfully provide
a voluntary early retirement incentive plan that is consistent with the
purposes of ADEA.\106\
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\105\ See ADEA sec. 4(I)(1).
\106\ See ADEA sec. 4(f)(2).
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REASONS FOR CHANGE
The Committee is aware that some public school districts
and related tax-exempt education associations provide certain
employees with voluntary early retirement incentive benefits
similar to benefits that can be provided under a defined
benefit pension plan. If provided under a defined benefit
pension plan, these benefits would not be includible in income
until paid and would also generally be permitted under ADEA.
However, for reasons related to the structure of State-
maintained defined benefit pension plans covering these
employees and fiscal operations of the local school districts,
these benefits are provided to the employees directly, rather
than under the defined benefit pension plan. The Committee
believes it is appropriate to treat these benefits in a manner
similar to the treatment that would apply if the benefits were
provided under the defined benefit pension plan. The Committee
also believes that it is appropriate to address the treatment
of certain employment retention plans maintained by local
school districts and related tax-exempt education associations.
EXPLANATION OF PROVISION
Early retirement incentive plans of local educational agencies and
education associations
The provision addresses the treatment of certain voluntary
early retirement incentive plans under section 457, ERISA, and
ADEA.
Code section 457
Under the provision, special rules apply under section 457
to a voluntary early retirement incentive plan that is
maintained by a local educational agency or a tax-exempt
education association which principally represents employees of
one or more such agencies and that makes payments or
supplements as an early retirement benefit, a retirement-type
subsidy, or a social security supplement in coordination with a
defined benefit pension plan maintained by a State or local
government or by such an association. Such a voluntary early
retirement incentive plan is treated as a bona fide severance
plan for purposes of section 457, and therefore is not subject
to the limits under section 457, to the extent the payments or
supplements could otherwise be provided under the defined
benefit pension plan. For purposes of the provision, the
payments or supplements that could otherwise be provided under
the defined benefit pension plan are to be determined by
applying the accrual and vesting rules for defined benefit
pension plans.\107\
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\107\ The accrual and vesting rules have the effect of limiting the
social security supplements and early retirement benefits that may be
provided under a defined benefit pension plan; however, government
plans are exempt from these rules.
---------------------------------------------------------------------------
ERISA
In addition, such voluntary early retirement incentive
plans are treated as a welfare benefit plan for purposes of
ERISA (other than a governmental plan that is exempt from
ERISA).
ADEA
The provision also addresses the treatment under ADEA of
voluntary early retirement incentive plans that are maintained
by local educational agencies and tax-exempt education
associations which principally represent employees of one or
more such agencies, and that make payments or supplements that
constitute the subsidized portion of an early retirement
benefit or a social security supplement and that are made in
coordination with a defined benefit pension plan maintained by
a State or local government or by such an association. Under
the provision, for purposes of ADEA, such a plan is treated as
part of the defined benefit pension plan and the payments or
supplements under the plan are not severance pay that may be
subject to certain deductions under ADEA.
Employment retention plans of local educational agencies and education
associations
The provision addresses the treatment of certain employment
retention plans under section 457 and ERISA. The provision
applies to employment retention plans that are maintained by
local educational agencies or tax-exempt education associations
which principally represent employees of one or more such
agencies and that provide compensation to an employee (payable
on termination of employment) for purposes of retaining the
services of the employee or rewarding the employee for service
with educational agencies or associations.
Under the provision, special tax treatment applies to the
portion of an employment retention plan that provides benefits
that do not exceed twice the applicable annual dollar limit on
deferrals under section 457 ($13,000 for 2004). The provision
provides an exception from the rules under section 457 for
ineligible plans with respect to such portion of an employment
retention plan. This exception applies for years preceding the
year in which benefits under the employment retention plan are
paid or otherwise made available to the employee. In addition,
such portion of an employment retention plan is not treated as
providing for the deferral of compensation for tax purposes.
Under the provision, an employment retention plan is also
treated as a welfare benefit plan for purposes of ERISA (other
than a governmental plan that is exempt from ERISA).
EFFECTIVE DATE
The provision is generally effective on the date of
enactment. The amendments to section 457 apply to taxable years
ending after the date of enactment. The amendments to ERISA
apply to plan years ending after the date of enactment. Nothing
in the provision alters or affects the construction of the
Code, ERISA, or ADEA as applied to any plan, arrangement, or
conduct to which the provision does not apply.
10. Two-year extension of transition rule to pension funding
requirements (sec. 769(c) of the Retirement Protection Act of
1994)
PRESENT LAW \108\
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\108\ Present law refers to the law in effect on the dates of
Committee action on the bill. It does not reflect the changes made by
the Pension Equity Funding Act of 2004, Pub. L. No. 108-218 (April 10,
2004).
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Under present law, defined benefit plans are required to
meet certain minimum funding rules. In some cases, additional
contributions are required if a defined benefit plan is
underfunded. Additional contributions generally are not
required in the case of a plan with a funded current liability
percentage of at least 90 percent. A plan's funded current
liability percentage is the value of plan assets as a
percentage of current liability. In general, a plan's current
liability means all liabilities to employees and their
beneficiaries under the plan. In the case of a plan with a
funded current liability percentage of less than 100 percent
for the preceding plan year, estimated contributions for the
current plan year must be made in quarterly installments during
the current plan year.
The PBGC insures benefits under most single-employer
defined benefit plans in the event the plan is terminated with
insufficient assets to pay for plan benefits. The PBGC is
funded in part by a flat-rate premium per plan participant, and
a variable rate premium based on the amount of unfunded vested
benefits under the plan. A specified interest rate and a
specified mortality table apply in determining unfunded vested
benefits for this purpose.
Under present law, a special rule modifies the minimum
funding requirements in the case of certain plans. The special
rule applies in the case of plans that (1) were not required to
pay a variable rate PBGC premium for the plan year beginning in
1996, (2) do not, in plan years beginning after 1995 and before
2009, merge with another plan (other than a plan sponsored by
an employer that was a member of the controlled group of the
employer in 1996), and (3) are sponsored by a company that is
engaged primarily in interurban or interstate passenger bus
service.
The special rule treats a plan to which it applies as
having a funded current liability percentage of at least 90
percent for plan years beginning after 1996 and before 2005 if
for such plan year the funded current liability percentage is
at least 85 percent. If the funded current liability of the
plan is less than 85 percent for any plan year beginning after
1996 and before 2005, the relief from the minimum funding
requirements applies only if certain specified contributions
are made.
For plan years beginning after 2004 and before 2010, the
funded current liability percentage will be deemed to be at
least 90 percent if the actual funded current liability
percentage is at least at certain specified levels. The relief
from the minimum funding requirements applies for a plan year
beginning in 2005, 2006, 2007, or 2008 only if contributions to
the plan for the plan year equal at least the expected increase
in current liability due to benefits accruing during the plan
year.
REASONS FOR CHANGE
The present-law funding rules for plans maintained by
certain interstate bus companies were enacted because the
generally applicable funding rules required greater
contributions for such plans than were warranted given the
special characteristics of such plans. In particular, these
plans are closed to new participants and have demonstrated
mortality significantly greater than that predicted under
mortality tables that the plans would otherwise be required to
use for minimum funding purposes. The Committee believes that
it is appropriate to provide an extension of the special
minimum funding rules for these plans for two years.
EXPLANATION OF PROVISION
[The bill does not include the provision relating to the
special funding rules for plans sponsored by a company engaged
primarily in interurban or interstate passenger bus service as
approved by the Committee because an identical provision was
enacted into law in the Pension Funding Equity Act of 2004
(Pub. L. No. 108-218) subsequent to Committee action on the
bill. The following discussion describes the Committee action.]
The provision approved by the Committee would have modified
the special funding rules for plans sponsored by a company
engaged primarily in interurban or interstate passenger bus
service by providing that, for plan years beginning in 2004 and
2005, the funded current liability percentage of the plan would
be treated as at least 90 percent for purposes of determining
the amount of required contributions (100 percent for purposes
of determining whether quarterly contributions are required).
As a result, for these years, additional contributions and
quarterly contributions would not be required with respect to
the plan. In addition, for these years, the mortality table
used under the plan would be used in determining the amount of
unfunded vested benefits under the plan for purposes of
calculating PBGC variable rate premiums.
EFFECTIVE DATE
The provision approved by the Committee would have been
effective with respect to plan years beginning after December
31, 2003.
11. Acceleration of PBGC computation of benefits attributable to
recoveries from employers (sec. 441 of the bill and secs.
4022(c) and 4062(c) of ERISA)
PRESENT LAW
In general
The Pension Benefit Guaranty Corporation (``PBGC'')
provides insurance protection for participants and
beneficiaries under certain defined benefit pension plans by
guaranteeing certain basic benefits under the plan in the event
the plan is terminated with insufficient assets to pay promised
benefits.\109\ The guaranteed benefits are funded in part by
premium payments from employers who sponsor defined benefit
plans. In general, the PBGC guarantees all basic benefits which
are payable in periodic installments for the life (or lives) of
the participant and his or her beneficiaries and are non-
forfeitable at the time of plan termination. For plans
terminating in 2004, the maximum guaranteed benefit for an
individual retiring at age 65 is $3,698.86 per month, or
$44,386.32 per year.
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\109\ The PBGC termination insurance program does not cover plans
of professional service employers that have fewer than 25 participants.
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The PBGC pays plan benefits, subject to the guarantee
limits, when it becomes trustee of a terminated plan. The PBGC
also pays amounts in addition to the guarantee limits
(``additional benefits'') if there are sufficient plan assets,
including amounts recovered from the employer for unfunded
benefit liabilities and contributions owed to the plan. The
employer (including members of its controlled group) is
statutorily liable for these amounts.
Plan underfunding recoveries
The PBGC's recoveries on its claims for unfunded benefit
liabilities are shared between the PBGC and plan participants.
The amounts recovered are allocated partly to the PBGC to help
cover its losses for paying unfunded guaranteed benefits and
partly to participants to help cover the loss of benefits that
are above the PBGC's guarantees and are not funded. In
determining the portion of the recovered amounts that will be
allocated to participants, present law specifies the use of an
average recovery ratio, rather than the actual amount recovered
for each specific plan. The average recovery ratio that applies
to a plan includes the PBGC's actual recovery experience for
plan terminations in the five-year period immediately preceding
the year the particular plan is terminated.
The average recovery ratio is used for all but very large
plans taken over by the PBGC. For a very large plan (i.e., a
plan for which participants' benefit losses exceed $20 million)
actual recovery amounts with respect to the specific plan are
used to determine the portion of the amounts recovered that
will be allocated to participants.
Recoveries for due and unpaid employer contributions
Amounts recovered from an employer for contributions owed
to the plan are treated as plan assets and are allocated to
plan benefits in the same manner as other assets in the plan's
trust on the plan termination date. The amounts recovered are
determined on a plan-specific basis rather than based on an
historical average recovery ratio.
REASONS FOR CHANGE
The Committee wishes to modify the rules for calculating
certain recoveries by the PBGC to accelerate the time by which
such recoveries can be determined, thereby accelerating the
time by which benefits may be paid to participants in
terminated plans.
EXPLANATION OF PROVISION
The provision makes two amendments to the PBGC insurance
provisions of ERISA. First, it changes the five-year period
used to determine the average recovery ratio for unfunded
benefit liabilities so that the period begins two years
earlier. For example, the average recovery ratio for a plan
terminating in 2004 is based on recovery experience for plan
terminations in 1997-2001, rather than 1999-2003.
In addition, the provision creates an average recovery
ratio for determining amounts recovered for contributions owed
to the plan, based on the PBGC's recovery experience over the
same five-year period.
The provision does not apply to very large plans (i.e.,
plans for which participants' benefit losses exceed $20
million). As under present law, in the case of a very large
plan, actual amounts recovered for unfunded benefit liabilities
and for contributions owed to the plan are used to determine
the amount available to provide additional benefits to
participants.
EFFECTIVE DATE
The provision is effective for any plan termination for
which notices of intent to terminate are provided (or, in the
case of a termination by the PBGC, a notice of determination
that the plan must be terminated is issued) on or after the
date that is 30 days after the date of enactment.
12. Multiemployer plan funding and solvency notices (sec. 442 of the
bill and sec. 101 of ERISA)
PRESENT LAW \110\
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\110\ Present law refers to the law in effect on the dates of
Committee action on the bill. It does not reflect the changes made by
the Pension Funding Equity Act of 2004 (``PFEA 2004''), Pub. L. No.
108-218 (April 10, 2004). Section 103 of PFEA 2004 requires all
multiemployer plans to provide an annual notice that contains certain
information relating to the plan and its funding status and certain
information relating to PBGC coverage of multiemployer plan benefits. A
civil penalty is assessable for failures to provide the required
notice. Section 103 of PFEA 2004 is effective for plan years beginning
after December 31, 2004.
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Under present law, defined benefit plans are generally
required to meet certain minimum funding rules. These rules are
designed to help ensure that such plans are adequately funded.
Both single-employer plans and multiemployer plans are subject
to minimum funding requirements; however, the requirements are
different for each type of plan.
Similarly, the Pension Benefit Guaranty Corporation
(``PBGC'') insures certain benefits under both single-employer
and multiemployer defined benefit plans, but the rules relating
to the guarantee vary for each type of plan. In the case of
multiemployer plans, the PBGC guarantees against plan
insolvency. Under its multiemployer program, PBGC provides
financial assistance through loans to plans that are insolvent
(that is, plans that are unable to pay basic PBGC-guaranteed
benefits when due).
Employers maintaining single-employer defined benefit plans
are required to provide certain notices to plan participants
relating to the funding status of the plan. For example, ERISA
requires an employer which sponsors a single-employer defined
benefit plan to notifyplan participants if the employer fails
to make required contributions (unless a request for a funding waiver
is pending).\111\ In addition, in the case of an underfunded plan for
which variable rate PBGC premiums are required, the plan administrator
generally must notify plan participants of the plan's funding status
and the limits on the PBGC benefit guarantee if the plan terminates
while underfunded.\112\
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\111\ ERISA sec. 101(d).
\112\ ERISA sec. 4011. Multiemployer plans are not required to pay
variable rate premiums.
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Employers maintaining multiemployer defined benefit plans
which are in reorganization status are required to provide plan
participants with certain information if the plan becomes
insolvent. If such a plan becomes insolvent, employers must
notify plan participants that certain benefit payments will be
suspended but that basic benefits will continue to be
paid.\113\
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\113\ Code sec. 418E; ERISA sec. 4245.
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REASONS FOR CHANGE
The Committee believes that participants in multiemployer
plans should be furnished with information about the plan's
funded status and the limitations on the guarantee of benefits
by the PBGC, including the circumstances in which the guarantee
would come into effect. The Committee also believes that such
participants should be provided with information about the
value of the plan's assets and the amount of benefit payments
as well as the rules governing insolvent multiemployer plans.
Requiring administrators of multiemployer plans to provide
participants with annual notices regarding plan funding and
solvency will help keep participants in multiemployer plans
adequately informed about their retirement benefits.
EXPLANATION OF PROVISION
In general
Under the provision, the administrator of a multiemployer
plan which is a defined benefit pension plan is required to
provide: (1) an annual funding notice; and (2) if the value of
the plan's assets as of the end of the plan year is less than
five times the amount of benefits paid by the plan for the
year, a solvency notice, to (1) each participant and
beneficiary; (2) each labor organization representing such
participants and beneficiaries; and (3) each employer that has
an obligation to contribute under the plan.
Both notices are required to include (1) identifying
information, including the name of the plan, the address and
phone number of the plan administrator and the plan's principal
administrative officer, each plan sponsor's employer
identification number, and the plan identification number; (2)
a general description of the benefits under the plan that are
eligible to be guaranteed by the PBGC, an explanation of the
limitations on the guarantee of benefits by the PBGC, and the
circumstances in which the guarantee would come into effect;
and (3) any additional information which the plan administrator
elects to include.
The notices must be provided no later than two months after
the due date (including extensions) for filing the plan's
annual report for the plan year to which the notices relate and
may be issued together, and may be issued with another
document, including the required summary annual report. The
notices must be provided in a form and manner prescribed in
PBGC regulations and must be written so as to be understood by
the average plan participant and may be provided in written,
electronic, or other appropriate form to the extent that it is
reasonably accessible by plan participants and beneficiaries.
Additional information to be included
Funding notice
In addition to the information described above, the
required annual funding notice must also include a statement as
to whether the plan's funded current liability percentage for
the plan year to which the notice relates is at least 100
percent (and if not, a statement of the percentage).
Solvency notice
In addition to the information described above, a solvency
notice must include (1) a statement of the value of the plan's
assets, the amount of benefit payments, and the ratio of the
assets to the payments for the plan year to which the notice
relates and (2) a summary of the rules governing insolvent
multiemployer plans, including the applicable limitation on
benefit payments and potential benefit reductions and
suspensions, and their potential effect on the plan.
Sanction for failure to provide notice
In the case of a failure to provide either of the required
notices, the Secretary of Labor may assess a civil penalty
against a plan administrator of up to $100 per day for each
failure to provide a notice. For this purpose, each violation
with respect to a single participant or beneficiary is treated
as a separate violation.
EFFECTIVE DATE
The provision applies to plan years beginning after
December 31, 2005.
13. No reduction in unemployment compensation as a result of pension
rollovers (sec. 443 of the bill and sec. 3304(a)(15) of the
Code)
PRESENT LAW
Under present law, unemployment compensation payable by a
State to an individual generally is reduced by the amount of
retirement benefits received by the individual. Distributions
from certain employer-sponsored retirement plans or IRAs that
are transferred to a similar retirement plan or IRA (``rollover
distributions'') generally are not includible in income. Some
States currently reduce the amount of an individual's
unemployment compensation by the amount of a rollover
distribution.
REASONS FOR CHANGE
Unlike an individual's unemployment compensation, rollover
distributions are not intended to meet current living expenses.
To the extent that a reduction of an individual's unemployment
compensation results in that individual liquidating a portion
of a rollover distribution to meet current living expenses, the
Committee believes that the purpose of the rules permitting
rollover distributions, which are designed to ensure that the
amounts contributed to employer-sponsored retirement plans or
IRAs are used for retirement purposes, are defeated.
EXPLANATION OF PROVISION
The proposal amends the Code so that the reduction of
unemployment compensation payable to an individual by reason of
the receipt of retirement benefits does not apply in the case
of a rollover distribution.
EFFECTIVE DATE
The proposal is effective for weeks beginning on or after
the date of enactment.
14. Withholding on certain distributions from governmental eligible
deferred compensation plans (sec. 444 of the bill and sec. 457
of the Code)
PRESENT LAW
Before the Economic Growth and Tax Relief Reconciliation
Act of 2001 \114\ (``EGTRRA''), distributions from an eligible
deferred compensation plan under section 457 (a ``section 457
plan'') were subject to the withholding rules for wages, rather
than the withholding rules for distributions from qualified
retirement plans. Under the wage withholding rules, graduated
withholding applies based on the amount of the wages. Under the
withholding rules for qualified retirement plans, an individual
may generally elect not to have taxes withheld from
distributions. However, withholding is required at a 20-percent
rate in the case of an eligible rollover distribution that is
not automatically rolled over into another retirement plan.
Eligible rollover distributions include distributions that are
payable over a period of less than 10 years.
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\114\ Pub. L. No. 107-16.
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EGTRRA conformed the rollover rules and withholding rules
for governmental section 457 plans to the rules for qualified
retirement plans.\115\ The EGTRRA changes are effective for
distributions after December 31, 2001. As a result, as of 2002,
required withholding at a 20-percent rate applies to
distributions made from a governmental section 457 plan for a
period of less than 10 years, including distributions that
began before the effective date of the EGTRRA changes.
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\115\ EGTRRA sec. 641.
---------------------------------------------------------------------------
REASONS FOR CHANGE
The Committee believes that distributions that have already
begun from governmental section 457 plans under the prior-law
rules should not have to be modified to conform to the EGTRRA
withholding provisions.
EXPLANATION OF PROVISION
Under the provision, the pre-EGTRRA withholding rules may
be applied to distributions from a governmental section 457
plan if the distribution is part of a series of distributions
which began before January 1, 2002, and is payable for less
than 10 years.
EFFECTIVE DATE
The provision is effective as if included in EGTRRA.
15. Minimum cost requirement for excess asset transfers (sec. 445 of
the bill and sec. 420 of the Code)
PRESENT LAW
Defined benefit plan assets generally may not revert to an
employer prior to termination of the plan and satisfaction of
all plan liabilities. In addition, a reversion may occur only
if the plan so provides. A reversion prior to plan termination
may constitute a prohibited transaction and may result in plan
disqualification. Any assets that revert to the employer upon
plan termination are includible in the gross income of the
employer and subject to an excise tax. The excise tax rate is
20 percent if the employer maintains a replacement plan or
makes certain benefit increases in connection with the
termination; if not, the excise tax rate is 50 percent. Upon
plan termination, the accrued benefits of all plan participants
are required to be 100-percent vested.
A pension plan may provide medical benefits to retired
employees through a separate account that is part of such plan.
A qualified transfer of excess assets of a defined benefit plan
to such a separate account within the plan may be made in order
to fund retiree health benefits.\116\ A qualified transfer does
not result in plan disqualification, is not a prohibited
transaction, and is not treated as a reversion. Thus,
transferred assets are not includible in the gross income of
the employer and are not subject to the excise tax on
reversions. No more than one qualified transfer may be made in
any taxable year. No qualified transfer may be made after
December 31, 2013.\117\
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\116\ Sec. 420.
\117\ Under present law in effect on the dates of Committee action
on the bill, no qualified transfer could be made after December 31,
2005.
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Excess assets generally means the excess, if any, of the
value of the plan's assets \118\ over the greater of (1) the
accrued liability under the plan (including normal cost) or (2)
125 percent of the plan's current liability.\119\ In addition,
excess assets transferred in a qualified transfer may not
exceed the amount reasonably estimated to be the amount that
the employer will pay out of such account during the taxable
year of the transfer for qualified current retiree health
liabilities. No deduction is allowed to the employer for (1) a
qualified transfer or (2) the payment of qualified current
retiree health liabilities out of transferred funds (and any
income thereon).
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\118\ The value of plan assets for this purpose is the lesser of
fair market value or actuarial value.
\119\ In the case of plan years beginning before January 1, 2004,
excess assets generally means the excess, if any, of the value of the
plan's assets over the greater of (1) the lesser of (a) the accrued
liability under the plan (including normal cost) or (b) 170 percent of
the plan's current liability (for 2003), or (2) 125 percent of the
plan's current liability. The current liability full funding limit was
repealed for years beginning after 2003. Under the general sunset
provision of EGTRRA, the limit is reinstated for years after 2010.
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Transferred assets (and any income thereon) must be used to
pay qualified current retiree health liabilities for the
taxable year of the transfer. Transferred amounts generally
must benefit pension plan participants, other than key
employees, who are entitled upon retirement to receive retiree
medical benefits through the separate account. Retiree health
benefits of key employees may not be paid out of transferred
assets.
Amounts not used to pay qualified current retiree health
liabilities for the taxable year of the transfer are to be
returned to the general assets of the plan. These amounts are
not includible in the gross income of the employer, but are
treated as an employer reversion and are subject to a 20-
percent excise tax.
In order for a transfer to be qualified, accrued retirement
benefits under the pension plan generally must be 100-percent
vested as if the plan terminated immediately before the
transfer (or in the case of a participant who separated in the
one-year period ending on the date of the transfer, immediately
before the separation).
In order to for a transfer to be qualified, the transfer
must meet the minimum cost requirement. To satisfy the minimum
cost requirement, an employer generally must maintain retiree
health benefits at the same level for the taxable year of the
transfer and the following four years (referred to as the cost
maintance period). The applicable employer cost during the cost
maintenance period cannot be less than the higher of the
applicable employer costs for each of the two taxable years
preceding the taxable year of the transfer. The applicable
employer cost is generally determined by dividing the current
retiree health liabilities by the number of individuals
provided coverage for applicable health benefits during the
year. The Secretary is directed to prescribe regulations as may
be necessary to prevent an employer who significantly reduces
retiree health coverage during the period from being treated as
satisfying the minimum cost requirement.
Under Treasury regulations,\120\ the minimum cost
requirement is not satisfied if the employer significantly
reduces retiree health coverage during the cost maintenance
period. Under the regulations, an employer significantly
reduces retiree health coverage for a year (beginning after
2001) during the cost maintenance period if either (1) the
employer-initiated reduction percentage for that taxable year
exceeds 10 percent, or (2) the sum of the employer-initiated
reduction percentages for that taxable year and all prior
taxable years during the cost maintenance period exceeds 20
percent.\121\ The employer-initiated reduction percentage is
percentage of the number of individuals receiving coverage for
applicable health benefits as of the day before the first day
of the taxable year over the total number of such individuals
whose coverage for applicable health benefits ended during the
taxable year by reason of employer action.\122\
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\120\ Treas. Reg. sec. 1.420-1(a).
\121\ Treas. Reg. sec. 1.420-1(b)(1).
\122\ Treas. Reg. sec. 1.420-1(b)(2).
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REASONS FOR CHANGE
The Committee believes that it is appropriate to provide
greater flexibility in complying with the minimum cost
requirement. The Committee believes that the requirement should
not be violated if the reduction in health cost is not more
that the allowable reduction in retiree health coverage.
EXPLANATION OF PROVISION
The provision provides that an employer does not fail the
minimum cost requirement if, in lieu of any reduction of health
coverage permitted by Treasury regulations, the employer
reduces applicable employer cost by an amount not in excess of
the reduction in costs which would have occurred if the
employer had made the maximum permissible reduction in retiree
health coverage under such regulations.
In applying such regulations to any subsequent taxable
year, any reduction in applicable employer cost under the
proposal shall be treated as if it were an equivalent reduction
in retiree health coverage.
EFFECTIVE DATE
The provision is effective for taxable years ending after
date of enactment.
16. Social Security coverage under divided retirement system for public
employees in Kentucky
PRESENT LAW \123\
Under Section 218 of the Social Security Act, a State may
choose whether or not its State and local government employees
who are covered by an employer-sponsored pension plan may also
participate in the Social Security Old-Age, Survivors, and
Disability Insurance program. (In this context, the term
``employer-sponsored pension plan'' refers to a pension,
annuity, retirement, or similar fund or system established by a
State or a political subdivision of a State such as a town.
Under present law, State or local government employees not
covered by an employer-sponsored pension plan already are, with
a few exceptions, mandatorily covered by Social Security.)
---------------------------------------------------------------------------
\123\ Present law refers to the law in effect on the dates of
Committee action on the bill. It does not reflect the changes made by
the Social Security Protection Act of 2004, Pub. L. No. 108-203 (March
2, 2004).
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Social Security coverage for employees covered under a
State or local government employer-sponsored pension plan is
established through an agreement between the State and the
Federal Government. In most States, before the agreement can be
made, employees who are members of the employer-sponsored
pension plan must agree to Social Security coverage by majority
vote in referendum. If the majority vote is in favor of Social
Security coverage, then the entire group, including those
voting against such coverage, will be covered by Social
Security. If the majority vote is against Social Security
coverage, then the entire group, including those voting in
favor of such coverage and employees hired after the
referendum, will not be covered by Social Security.
In certain States, however, if employees who already are
covered in an employer-sponsored pension plan are not in
agreement about whether to participate in the Social Security
system, coverage can be extended only to those who choose it,
provided that all newly hired employees of the system are
mandatorily covered under Social Security. To establish such a
divided retirement system, the state must conduct a referendum
among members of the employer-sponsored pension plan. After the
referendum, the retirement system is divided into two groups,
one composed of members who elected Social Security coverage
and those hired after the referendum, and the other composed of
the remaining members of the employer-sponsored pension plan.
Under Section 218(d)(6)(c) of the Social Security Act, 21
States currently have authority to operate a divided retirement
system.
REASONS FOR CHANGE
The Committee believes that it is appropriate to allow the
State of Kentucky to offer a divided retirement system.
EXPLANATION OF PROVISION
[The bill does not include the provision relating to
allowing the State of Kentucky to offer a divided retirement
system as approved by the Committee because an identical
provision was enacted into law in the Social Security
Protection Act of 2004 (Pub. L. No. 108-203) subsequent to
Committee action on the bill. The following discussion
describes the Committee action.]
The provision approved by the Committee would have
permitted the State of Kentucky to join the 21 other States in
being able to offer a divided retirement system. This system
would permit current state and local government workers in an
employer-sponsored pension plan to elect Social Security
coverage on an individual basis. Those who do not wish to be
covered by Social Security would continue to participate
exclusively in the employer-sponsored pension plan.
The governments of the City of Louisville and Jefferson
County were to have been merged in January 2003 and a new
retirement system was to be formed. Under the provision, each
employee under the new system could choose whether or not to
participate in the Social Security system in addition to their
employer-sponsored pension plan. As under present law, all
employees newly hired to the system after the divided system is
in place would be covered automatically under Social Security.
EFFECTIVE DATE
The provision approved by the Committee would have been
effective on January 1, 2003.
D. Studies
(Secs. 451 and 452 of the bill)
PRESENT LAW
Qualified retirement plans are broadly classified into two
categories under the Code, defined benefit plans and defined
contribution plans, based on the nature of the benefits
provided. Under a defined benefit plan, benefits are determined
under a plan formula, such as a formula based on the
participant's compensation and years of service. Subject to
certain limits, benefits under a defined benefit plan are
guaranteed by the PBGC.
Under a defined contribution plan, benefits are based
solely on contributions allocated to separate accounts for each
plan participant (as adjusted by gains, losses, and expenses).
Benefits under defined contribution plans are not insured by
the PBGC.
Under ERISA, defined contribution plans are referred to as
``individual account plans.'' Individual account plans may
provide that plan participants may direct the investment of
assets allocated to their accounts. If certain requirements are
satisfied, ERISA fiduciary liability does not apply to
investment decisions made by plan participants under an
individual account plan.\124\
---------------------------------------------------------------------------
\124\ ERISA sec. 404(c).
---------------------------------------------------------------------------
ERISA generally prohibits qualified retirement plans from
acquiring employer securities if, after the acquisition, more
than 10 percent of the assets of the plan would be invested in
employer securities.\125\ This 10-percent limitation does not
apply to eligible individual account plans.
---------------------------------------------------------------------------
\125\ ERISA sec. 407. The 10-percent limitation also applies to
employer real property.
---------------------------------------------------------------------------
A floor-offset arrangement is an arrangement under which
benefits payable to a participant under a defined benefit plan
are reduced by benefits under an individual account plan. The
10-percent limitation on the acquisition of employer securities
applies to an individual account plan that is part of a floor-
offset arrangement, unless the floor-offset arrangement was
established on or before December 17, 1987.
An employee stock ownership plan (an ``ESOP'') is an
individual account plan that is designed to invest primarily in
employer securities and which meets certain other requirements.
ESOPs are not subject to the 10-percent limit on the
acquisition of employer securities, unless the ESOP is part of
a floor-offset arrangement (as described above).
REASONS FOR CHANGE
The Committee has a continuing interest in retirement
income security and in the roles that defined contribution
plans and defined benefit plans play in providing that
security. The Committee believes it is appropriate to conduct
studies of certain issues relating to such plans to determine
ways in which retirement security may be enchanced.
EXPLANATION OF PROVISION
Study on revitalizing defined benefit plans
The Department of Treasury, the Department of Labor, and
the PBGC are directed to jointly undertake a study on ways to
revitalize employer interest in defined benefit plans. In
conducting the study, the Treasury and Labor Departments and
the PBGC are to consider: (1) ways to encourage the
establishment of defined benefit plans by small and mid-sized
employers; (2) ways to encourage the continued maintenance of
defined benefit plans by larger employers; and (3) legislative
proposals to accomplish these objectives.
Within two years after the date of enactment, the results
of the study, together with any recommendations for legislative
changes, are to be reported to the Senate Committees on Finance
and Health, Education, Labor, and Pensions and to the House
Committees on Ways and Means and Education and the Workforce.
Study on floor-offset ESOPs
The Department of the Treasury and the PBGC are directed to
undertake a study to determine the number of floor-offset ESOPs
still in existence and the extent to which such plans pose a
risk to plan participants or beneficiaries or the PBGC. The
study is to consider legislative proposals to address the risks
posed by floor-offset ESOPs.
Within one year after the date of enactment, the Department
of Treasury and the PBGC are to report the results of the
study, together with any recommendations for legislative
changes, to the Senate Committees on Finance and Health,
Education, Labor, and Pensions and the House Committees on Ways
and Means and Education and the Workforce.
EFFECTIVE DATE
The provisions are effective on the date of enactment.
E. Other Provisions
1. Additional IRA catch-up contributions for certain individuals (sec.
461 of the bill and sec. 408 of the Code)
PRESENT LAW
Under present law, favored tax treatment applies to
qualified retirement plans maintained by employers and to
individual retirement arrangements (``IRAs'').
Qualified defined contribution plans may permit both
employees and employers to make contributions to the plan.
Under a qualified cash or deferred arrangement (commonly
referred to as a ``section 401(k) plan''), employees may elect
to make pretax contributions to a plan, referred to as elective
deferrals. Employees may also be permitted to make after-tax
contributions to a plan. In addition, a plan may provide for
employer nonelective contributions or matching contributions.
Nonelective contributions are employer contributions that are
made without regard to whether the employee makes elective
deferrals or after-tax contributions. Matching contributions
are employer contributions that are made only if the employee
makes elective deferrals or after-tax contributions. Matching
contributions are sometimes made in the form of employer stock.
Under present law, an individual may generally make
contributions to an IRA for a taxable year up to the lesser of
a certain dollar amount or the individual's compensation. The
maximum annual dollar limit on IRA contributions to IRAs is
$3,000 for 2004, $4,000 for 2005-2007, and $5,000 for 2008,
with indexing thereafter. Individuals who have attained age 50
may make additional ``catch-up'' contributions to an IRA for a
taxable year of up to $500 in 2004-2005 and $1,000 in 2006 and
thereafter.
REASONS FOR CHANGE
The Committee recognizes that, if employer matching
contributions are made in the form of employer stock, the
employer's bankruptcy may cause employees to lose a substantial
portion of their retirement savings. The Committee believes
that employees should be permitted to make up for such losses
by making additional IRA contributions.
EXPLANATION OF PROVISION
Under the provision, an eligible individual would be
permitted to make additional contributions to an IRA up to
$1,500 per year in 2004 and 2005, and $3,000 per year in 2006-
2008. To be eligible to make these additional contributions, an
individual must have been a participant in a section 401(k)
plan under which the employer matched at least 50 percent of
the employee's contribution to the plan with stock of the
employer. In addition, (1) the employer must have filed for
bankruptcy, (2) the employer or any other person must have been
subject to an indictment or conviction resulting from business
transactions related to the bankruptcy, and (3) the individual
was a participant in the section 401(k) plan on the date six
months before the employer filed for bankruptcy. An individual
eligible to make these additional contributions is not
permitted to make IRA catch-up contributions that apply to
individuals age 50 and older.
EFFECTIVE DATE
The provision is effective for taxable years beginning
after December 31, 2003, and before January 1, 2009.
2. Distributions by an S corporation to an employee stock ownership
plan (sec. 462 of the bill and sec. 4975 of the Code)
PRESENT LAW
An employee stock ownership plan (an ``ESOP'') is a defined
contribution plan that is designated as an ESOP and is designed
to invest primarily in qualifying employer securities. For
purposes of ESOP investments, a ``qualifying employer
security'' is defined as: (1) publicly traded common stock of
the employer or a member of the same controlled group; (2) if
there is no such publicly traded common stock, common stock of
the employer (or member of the same controlled group) that has
both voting power and dividend rights at least as great as any
other class of common stock; or (3) noncallable preferred stock
that is convertible into common stock described in (1) or (2)
and that meets certain requirements. In some cases, an employer
may design a class of preferred stock that meets these
requirements and that is held only by the ESOP. Special rules
apply to ESOPs that do not apply to other types of qualified
retirement plans, including a special exemption from the
prohibited transaction rules.
Certain transactions between an employee benefit plan and a
disqualified person, including the employer maintaining the
plan, are prohibited transactions that result in the imposition
of an excise tax.\126\ Prohibited transactions include, among
other transactions, (1) the sale, exchange or leasing of
property, (2) the lending of money or other extension of
credit, and (3) the transfer to, or use by or for the benefit
of, the income or assets of the plan. However, certain
transactions are exempt from prohibited transaction treatment,
including certain loans to enable an ESOP to purchase
qualifying employer securities.\127\ In such a case, the
employer securities purchased with the loan proceeds are
generally pledged as security for the loan. Contributions to
the ESOP and dividends paid on employer stock held by the ESOP
are used to repay the loan. The employer stock is held in a
suspense account and released for allocation to participants'
accounts as the loan is repaid.
---------------------------------------------------------------------------
\126\ Sec. 4975.
\127\ Sec. 4975(d)(3). An ESOP that borrows money to purchase
employer stock is referred to as a ``leveraged'' ESOP.
---------------------------------------------------------------------------
A loan to an ESOP is exempt from prohibited transaction
treatment if the loan is primarily for the benefit of the
participants and their beneficiaries, the loan is at a
reasonable rate of interest, and the collateral given to a
disqualified person consists of only qualifying employer
securities. No person entitled to payments under the loan can
have the right to any assets of the ESOP other than (1)
collateral given for the loan, (2) contributions made to the
ESOP to meet its obligations on the loan, and (3) earnings
attributable to the collateral and the investment of
contributions described in (2).\128\ In addition, the payments
made on the loan by the ESOP during a plan year cannot exceed
the sum of those contributions and earnings during the current
and prior years, less loan payments made in prior years.
---------------------------------------------------------------------------
\128\ Treas. reg. sec. 54.4975-7(b)(5).
---------------------------------------------------------------------------
An ESOP of a C corporation is not treated as violating the
qualification requirements of the Code or as engaging in a
prohibited transaction merely because, in accordance with plan
provisions, a dividend paid with respect to qualifying employer
securities held by the ESOP is used to make payments on a loan
(including payments of interest as well as principal) that was
used to acquire the employer securities (whether or not
allocated to participants).\129\ In the case of a dividend paid
with respect to any employer security that is allocated to a
participant, this relief does not apply unless the plan
provides that employer securities with a fair market value of
not less than the amount of the dividend is allocated to the
participant for the year which the dividend would have been
allocated to the participant.\130\
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\129\ Sec. 404(k)(5)(B).
\130\ Sec. 404(k)(2)(B).
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Effective for taxable years beginning after December 31,
1997, a qualified retirement plan (including an ESOP) may be a
shareholder of an S corporation.\131\ As a result, an S
corporation may maintain an ESOP.
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\131\ Sec. 1361(c)(6).
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REASONS FOR CHANGE
The Committee believes that distributions made with respect
to S corporation stock that is held by an ESOP and that was
purchased with an exempt loan should be permitted to be used to
repay the loan, subject to the same conditions that apply to C
corporation dividends used to repay an exempt loan.
EXPLANATION OF PROVISION
Under the provision, an ESOP maintained by an S corporation
is not treated as violating the qualification requirements of
the Code or as engaging in a prohibited transaction merely
because, in accordance with plan provisions, a distribution
made with respect to S corporation stock that constitutes
qualifying employer securities held by the ESOP is used to
repay a loan that was used to acquire the securities (whether
or not allocated to participants). This relief does not apply
in the case of a distribution with respect to S corporation
stock that is allocated to a participant unless the plan
provides that stock with a fair market value of not less than
the amount of such distribution is allocated to the participant
for the year which the distribution would have been allocated
to the participant.
EFFECTIVE DATE
The provision is effective January 1, 1998.
3. Permit qualified transfers of excess pension assets to retiree
health accounts by multiemployer plan (sec. 463 of the bill,
sec. 420 of the Code and secs. 101, 403 and 408 of ERISA)
PRESENT LAW
Defined benefit plan assets generally may not revert to an
employer prior to termination of the plan and satisfaction of
all plan liabilities. In addition, a reversion may occur only
if the plan so provides. A reversion prior to plan termination
may constitute a prohibited transaction and may result in plan
disqualification. Any assets that revert to the employer upon
plan termination are includible in the gross income of the
employer and subject to an excise tax. The excise tax rate is
20 percent if the employer maintains a replacement plan or
makes certain benefit increases in connection with the
termination; if not, the excise tax rate is 50 percent. Upon
plan termination, the accrued benefits of all plan participants
are required to be 100-percent vested.
A pension plan may provide medical benefits to retired
employees through a separate account that is part of such plan.
A qualified transfer of excess assets of a defined benefit plan
to such a separate account within the plan may be made in order
to fund retiree health benefits.\132\ A qualified transfer does
not result in plan disqualification, is not a prohibited
transaction, and is not treated as a reversion. Thus,
transferred assets are not includible in the gross income of
the employer and are not subject to the excise tax on
reversions. No more than one qualified transfer may be made in
any taxable year. A qualified transfer may not be made from a
multiemployer plan. No qualified transfer may be made after
December 31, 2013.\133\
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\132\ Sec. 420.
\133\ Under present law in effect on the dates of Committee action
on the bill, no qualified transfer could be made after December 31,
2005.
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Excess assets generally means the excess, if any, of the
value of the plan's assets \134\ over the greater of (1) the
accrued liability under the plan (including normal cost) or (2)
125 percent of the plan's current liability.\135\ In addition,
excess assets transferred in a qualified transfer may not
exceed the amount reasonably estimated to be the amount that
the employer will pay out of such account during the taxable
year of the transfer for qualified current retiree health
liabilities. No deduction is allowed to the employer for (1) a
qualified transfer or (2) the payment of qualified current
retiree health liabilities out of transferred funds (and any
income thereon).
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\134\ The value of plan assets for this purpose is the lesser of
fair market value or actuarial value.
\135\ In the case of plan years beginning before January 1, 2004,
excess assets generally means the excess, if any, of the value of the
plan's assets over the greater of (1) the lesser of (a) the accrued
liability under the plan (including normal cost) or (b) 170 percent of
the plan's current liability (for 2003), or (2) 125 percent of the
plan's current liability. The current liability full funding limit was
repealed for years beginning after 2003. Under the general sunset
provision of EGTRRA, the limit is reinstated for years after 2010.
---------------------------------------------------------------------------
Transferred assets (and any income thereon) must be used to
pay qualified current retiree health liabilities for the
taxable year of the transfer. Transferred amounts generally
must benefit pension plan participants, other than key
employees, who are entitled upon retirement to receive retiree
medical benefits through the separate account. Retiree health
benefits of key employees may not be paid out of transferred
assets.
Amounts not used to pay qualified current retiree health
liabilities for the taxable year of the transfer are to be
returned to the general assets of the plan. These amounts are
not includible in the gross income of the employer, but are
treated as an employer reversion and are subject to a 20-
percent excise tax.
In order for the transfer to be qualified, accrued
retirement benefits under the pension plan generally must be
100-percent vested as if the plan terminated immediately before
the transfer (or in the case of a participant who separated in
the one-year period ending on the date of the transfer,
immediately before the separation).
In order to a transfer to be qualified, the employer
generally must maintain retiree health benefits at the same
level for the taxable year of the transfer and the following
four years.
In addition, the Employee Retirement Income Security Act of
1974 (``ERISA'') provides that, at least 60 days before the
date of a qualified transfer, the employer must notify the
Secretary of Labor, the Secretary of the Treasury, employee
representatives, and the plan administrator of the transfer,
and the plan administrator must notify each plan participant
and beneficiary of the transfer.\136\
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\136\ ERISA sec. 101(e). ERISA also provides that a qualified
transfer is not a prohibited transaction under ERISA or a prohibited
reversion.
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Under present law, special deduction rules apply to a
multiemployer defined benefit plan established before January
1, 1954, under an agreement between the Federal government and
employee representatives in a certain industry.\137\
---------------------------------------------------------------------------
\137\ Code sec. 404(c).
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REASONS FOR CHANGE
The Committee believes that it is appropriate to allow the
multiemployer defined benefit plan to which special deduction
rules apply to make qualified transfers of excess benefit plan
assets.
EXPLANATION OF PROVISION
The provision allows qualified transfers of excess defined
benefit plan assets to be made by the multiemployer defined
benefit plan to which special deduction rules apply (or a
continuation or spin-off thereof) that primarily covers
employees in the building and construction industry.
EFFECTIVE DATE
The provision is effective for transfers made in taxable
years beginning after December 31, 2004.
F. Plan Amendments
(Sec. 471 of the bill)
PRESENT LAW
Present law provides a remedial amendment period during
which, under certain circumstances, a plan may be amended
retroactively in order to comply with the qualification
requirements.\138\ In general, plan amendments to reflect
changes in the law generally must be made by the time
prescribed by law for filing the income tax return of the
employer for the employer's taxable year in which the change in
law occurs. The Secretary of the Treasury may extend the time
by which plan amendments need to be made.
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\138\ Sec. 401(b).
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The Code and ERISA provide that, in general, accrued
benefits cannot be reduced by a plan amendment.\139\ This
prohibition on the reduction of accrued benefits is commonly
referred to as the ``anticutback rule.''
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\139\ Code sec. 411(d)(6)l ERISA sec. 204(g).
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REASONS FOR CHANGE
The Committee believes that employers should have adequate
time to amend their plans to reflect changes in the law while
operating their plans in compliance with such changes.
EXPLANATION OF PROVISION
The provision permits certain plan amendments made pursuant
to the changes made by the bill or by the Economic Growth and
Tax Relief Reconciliation Act of 2001 \140\ (``EGTRRA''), or
regulations issued thereunder, to be retroactively effective.
If the plan amendment meets the requirements of the provision,
then the plan will be treated as being operated in accordance
with its terms and the amendment will not violate the
anticutback rule. In order for this treatment to apply, the
plan amendment is required to be made on or before the last day
of the first plan year beginning on or after January 1, 2006,
or such later date as provided by the Secretary of the
Treasury. Governmental plans are given an additional two years
in which to make required plan amendments. If the amendment is
required to be made to retain qualified status as a result of
the changes in the law (or regulations), the amendment is
required to be made retroactively effective as of the date on
which the change became effective with respect to the plan and
the plan is required to be operated in compliance until the
amendment is made. Amendments that are not required to retain
qualified status but that are made pursuant to the changes made
by the bill or EGTRRA (or applicable regulations) may be made
retroactively effective as of the first day the plan is
operated in accordance with the amendment.
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\140\ Pub. L. No. 107-16.
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A plan amendment will not be considered to be pursuant to
the bill or EGTRRA (or applicable regulations) if it has an
effective date before the effective date of the provision of
the bill or EGTRRA (or regulations) to which it relates.
Similarly, the provision does not provide relief from the
anticutback rule for periods prior to the effective date of the
relevant provision (or regulations) or the plan amendment.
The Secretary of the Treasury is authorized to provide
exceptions to the relief from the prohibition on reductions in
accrued benefits. It is intended that the Secretary will not
permit inappropriate reductions in contributions or benefits
that are not directly related to the provisions of the bill or
EGTRRA. For example, it is intended that a plan that
incorporates the section 415 limits by reference can be
retroactively amended to impose the section 415 limits in
effect before EGTTRA.\141\ On the other hand, suppose a plan
incorporates the section 401(a)(17) limit on compensation by
reference and provides for an employer contribution of three
percent of compensation. It is expected that the Secretary will
provide that, in that case, the plan cannot be amended
retroactively to reduce the contribution percentage for those
participants not affected by the section 401(a)(17) limit, even
though the reduction will result in the same dollar level of
contributions for some participants because of the increase in
compensation taken into account under the plan as a result of
the increase in the section 401(a)(17) limit under EGTRRA. As
another example, suppose that under present law a plan is top-
heavy and therefore a minimum benefit is required under the
plan, and that under the provisions of EGTRRA, the plan is not
considered to be top-heavy. It is expected that the Secretary
will generally permit plans to be retroactively amended to
reflect the new top-heavy provisions of EGTRRA.
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\141\ See also, section 411(j)(3) of the Job Creation and Worker
Assistance Act of 2002, which provides a special rule for plan
amendments adopted on or before June 30, 2002, in connection with
EGTRRA, in the case of a plan that incorporated the section 415 limits
by reference on June 7, 2001, the date of enactment of EGTRRA.
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EFFECTIVE DATE
The provision is effective on the date of enactment.
TITLE V. PROVISIONS RELATING TO EXECUTIVES AND STOCK OPTIONS
A. Repeal of Limitation on Issuance of Treasury Guidance Regarding
Nonqualified Deferred Compensation
(Sec. 501 of the bill)
PRESENT LAW
General tax treatment of nonqualified deferred compensation
The determination of when amounts deferred under a
nonqualified deferred compensation arrangement are includible
in the gross income of the individual earning the compensation
depends on the facts and circumstances of the arrangement. A
variety of tax principles and Code provisions may be relevant
in making this determination, including the doctrine of
constructive receipt, the economic benefit doctrine, the
provisions of section 83 relating generally to transfers of
property in connection with the performance of services, and
provisions relating specifically to nonexempt employee trusts
(sec. 402(b)) and nonqualified annuities (sec. 403(c)).
In general, the time for inclusion of nonqualified deferred
compensation depends on whether the arrangement is unfunded or
funded. If the arrangement is unfunded, then the compensation
is generally includible in income when it is actually or
constructively received. If the arrangement is funded, then
income is includible for the year in which the individual's
rights are transferable or not subject to a substantial risk of
forfeiture.
In general, an arrangement is considered funded if there
has been a transfer of property under section 83. Under that
section, a transfer of property occurs when a person acquires a
beneficial ownership interest in such property. The term
``property'' is defined very broadly for purposes of section
83.\142\ Property includes real and personal property other
than money or an unfunded and unsecured promise to pay money in
the future. Property also includes a beneficial interest in
assets (including money) that are transferred or set aside from
claims of the creditors of the transferor, for example, in a
trust or escrow account. Accordingly, if, in connection with
the performance of services, vested contributions are made to a
trust on an individual's behalf and the trust assets may be
used solely to provide future payments to the individual, the
payment of the contributions to the trust constitutes a
transfer of property to the individual that is taxable under
section 83. On the other hand, deferred amounts are generally
not includible in income in situations where nonqualified
deferred compensation is payable from general corporate funds
that are subject to the claims of general creditors, as such
amounts are treated as unfunded and unsecured promises to pay
money or property in the future.
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\142\ Treas. Reg. sec. 1.83-3(e). This definition in part reflects
previous IRS rulings on nonqualified deferred compensation.
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As discussed above, if the arrangement is unfunded, then
the compensation is generally includible in income when it is
actually or constructively received under section 451. Income
is constructively received when it is credited to an
individual's account, set apart, or otherwise made available so
that it can be drawn on at any time. Income is not
constructively received if the taxpayer's control of its
receipt is subject to substantial limitations or restrictions.
Arequirement to relinquish a valuable right in order to make
withdrawals is generally treated as a substantial limitation or
restriction.
Special statutory provisions govern the timing of the
deduction for nonqualified deferred compensation, regardless of
whether the arrangement covers employees or nonemployees and
regardless of whether the arrangement is funded or
unfunded.\143\ Under these provisions, the amount of
nonqualified deferred compensation that is includible in the
income of the individual performing services is deductible by
the service recipient for the taxable year in which the amount
is includible in the individual's income.
---------------------------------------------------------------------------
\143\ Secs. 404(a)(5), (b) and (d) and sec. 83(h).
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Rulings on nonqualified deferred compensation
In the 1960's and early 1970's, various IRS revenue rulings
considered the tax treatment of nonqualified deferred
compensation arrangements.\144\ Under these rulings, a mere
promise to pay, not represented by notes or secured in any way,
was not regarded as the receipt of income for tax purposes.
However, if an amount was contributed to an escrow account or
trust on the individual's behalf, to be paid to the individual
in future years with interest, the amount was held to be
includible in income under the economic benefit doctrine.
Deferred amounts were not currently includible in income in
situations in which nonqualified deferred compensation was
payable from general corporate funds that were subject to the
claims of general creditors and the plan was not funded by a
trust, or any other form of asset segregation to which
individuals had any prior or privileged claim.\145\ Similarly,
current income inclusion did not result when the employer
purchased an annuity contract to provide a source of funds for
its deferred compensation liability if the employer was the
applicant, owner and beneficiary of the annuity contract, and
the annuity contract was subject to the general creditors of
the employer.\146\ In these situations, deferred compensation
amounts were held to be includible in income when actually
received or otherwise made available.
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\144\ The seminal ruling dealing with nonqualified deferred
compensation is Rev. Rul. 60-31, 1960-1 C.B. 174.
\145\ Rev. Rul. 69-650, 1969-2 C.B. 106; Rev. Rul. 69-49, 1969-1
C.B. 138.
\146\ Rev. Rul. 72-25, 1972-1 C.B. 127. See also, Rev. Rul. 68-99,
1968-1 C.B. 193, in which the employer's purchase of an insurance
contract on the life of the employee did not result in an economic
benefit to the employee if all rights to any benefits under the
contract were solely the property of the employer and the proceeds of
the contract were payable only to the employer.
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Proposed Treasury regulation 1.61-16, published in the
Federal Register for February 3, 1978, provided that if a
payment of an amount of a taxpayer's compensation is, at the
taxpayer's option, deferred to a taxable year later than that
in which such amount would have been payable but for his
exercise of such option, the amount shall be treated as
received by the taxpayer in such earlier taxable year.\147\
---------------------------------------------------------------------------
\147\ Prop. Treas. Reg. 1.61-16, 43 Fed. Reg. 4638 (1978).
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Section 132 of the Revenue Act of 1978
Section 132 of the Revenue Act of 1978 \148\ was enacted in
response to proposed Treasury regulation 1.61-16. Section 132
of the Revenue Act of 1978 provides that the taxable year of
inclusion in gross income of any amount covered by a private
deferred compensation plan is determined in accordance with the
principles set forth in regulations, rulings, and judicial
decisions relating to deferred compensation which were in
effect on February 1, 1978. The term, ``private deferred
compensation plan'' means a plan, agreement, or arrangement
under which the person for whom service is performed is not a
State or a tax-exempt organization and under which the payment
or otherwise making available of compensation is deferred.
However, the provision does not apply to certain employer-
provided retirement arrangements (e.g., a qualified retirement
plan), a transfer of property under section 83, or an
arrangement that includes a nonexempt employees trust under
section 402(b). Section 132 was not intended to restrict
judicial interpretation of the law relating to the proper tax
treatment of deferred compensation or interfere with judicial
determinations of what principles of law apply in determining
the timing of income inclusion.\149\
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\148\ Pub. L. No. 95-600.
\149\ The legislative history to the provision states that the
Congress believed that the doctrine of constructive receipt should not
be applied to employees of taxable employers as it would have been
under the proposed regulation. The Congress also believed that the
uncertainty surrounding the status of deferred compensation plans of
taxable organizations under the proposed regulation was not desired and
should not be permitted to continue.
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REASONS FOR CHANGE
The Committee is aware of the popular use of deferred
compensation arrangements by executives to defer current
taxation of substantial amounts of income. Executives often use
arrangements that allow deferral of income, but also provide
security of future payment to the executive, even if the
arrangement, on its face, says otherwise. The Committee is
concerned that many nonqualified deferred compensation
arrangements have developed which allow improper deferral of
income.
The report issued by the staff of the Joint Committee on
Taxation on their investigation of Enron Corporation,\150\
which was mandated by the Committee, detailed how executives
deferred millions of dollars in Federal income taxes through
nonqualified deferred compensation arrangements. The staff of
the Joint Committee on Taxation found that the restriction
imposed by section 132 of the Revenue Act of 1978 may have
prevented Treasury from issuing more guidance on nonqualified
deferred compensation and may have contributed to aggressive
interpretations of present law. Especially given the lack of
statutory rules in this area, the lack of administrative
guidance allows taxpayers latitude to create and promote
arrangements that push the limit of what is allowed under the
law. The Joint Committee staff recommended the repeal of
section 132.
---------------------------------------------------------------------------
\150\ Joint Committee on Taxation, Report of Investigation of Enron
Corporation and Related Entities Regarding Federal Tax and Compensation
Issues, and Policy Recommendations (JCS-3-03), February 2003.
---------------------------------------------------------------------------
The Committee believes that the Secretary of the Treasury
should issue guidance on nonqualified deferred compensation
targeted to arrangements which result in improper deferral of
income and should not be bound by the restrictions imposed by
Section 132 of the Revenue Act of 1978, which may impede the
Treasury Department from issuing appropriate guidance to
address such arrangements.
EXPLANATION OF PROVISION
The provision repeals section 132 of the Revenue Act of
1978. The Committee intends that the Secretary of the Treasury
issue guidance with respect to the tax treatment of
nonqualified deferred compensation arrangements focusing on
arrangements that improperly defer income consistent with the
other provisions of the bill.
For example, it is intended that the Secretary address what
is considered a substantial limitation under the constructive
receipt doctrine and situations in which an individual's right
to receive compensation is, at least in form, subject to
substantial limitations, but in fact is not so limited. It is
also intended that the Secretary address arrangements which
purport to not be funded, but should be treated as so. In
addition, it is intended that the Secretary address
arrangements in which assets, by the technical terms of the
arrangements, appear to be subject to the claims of an
employer's general creditors, but practically are unavailable
to creditors.
It is not intended that the Secretary take the position (as
taken in proposed Treasury regulation 1.61-16) that all
elective nonqualified deferred compensation is currently
includible in income.
No inference is intended that the Secretary is prohibited
under present law from issuing any guidance with respect to
nonqualified deferred compensation arrangements or that any
existing nonqualified deferred compensation guidance issued by
the Secretary is invalid. In addition, no inference is intended
that any arrangements covered by future guidance provide
permissible deferrals of income under present law.
EFFECTIVE DATE
The provision is effective for taxable years beginning
after the date of enactment.
B. Taxation of Nonqualified Deferred Compensation
(Sec. 502 of the bill and new sec. 409A of the Code)
PRESENT LAW
In general
The determination of when amounts deferred under a
nonqualified deferred compensation arrangement are includible
in the gross income of the individual earning the compensation
depends on the facts and circumstances of the arrangement. A
variety of tax principles and Code provisions may be relevant
in making this determination, including the doctrine of
constructive receipt, the economic benefit doctrine,\151\ the
provisions of section 83 relating generally to transfers of
property in connection with the performance of services, and
provisions relating specifically to nonexempt employee trusts
(sec. 402(b)) and nonqualified annuities (sec. 403(c)).
---------------------------------------------------------------------------
\151\ See, e.g., Sproull v. Commissioner, 16 T.C. 244 (1951), aff'd
per curiam, 194 F.2d 541 (6th Cir. 1952); Rev. Rul. 60-31, 1960-1 C.B.
174.
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In general, the time for income inclusion of nonqualified
deferred compensation depends on whether the arrangement is
unfunded or funded. If the arrangement is unfunded, then the
compensation is generally includible in income when it is
actually or constructively received. If the arrangement is
funded, then income is includible for the year in which the
individual's rights are transferable or not subject to a
substantial risk of forfeiture.
Nonqualified deferred compensation is generally subject to
social security and Medicare taxes when the compensation is
earned (i.e., when services are performed), unless the
nonqualified deferred compensation is subject to a substantial
risk of forfeiture. If nonqualified deferred compensation is
subject to a substantial risk of forfeiture, it is subject to
social security and Medicare tax when the risk of forfeiture is
removed (i.e., when the right to the nonqualified deferred
compensation vests). This treatment is not affected by whether
the arrangement is funded or unfunded, which is relevant in
determining when amounts are includible in income (and subject
to income tax withholding).
In general, an arrangement is considered funded if there
has been a transfer of property under section 83. Under that
section, a transfer of property occurs when a person acquires a
beneficial ownership interest in such property. The term
``property'' is defined very broadly for purposes of section
83.\152\ Property includes real and personal property other
than money or an unfunded and unsecured promise to pay money in
the future. Property also includes a beneficial interest in
assets (including money) that are transferred or set aside from
claims of the creditors of the transferor, for example, in a
trust or escrow account. Accordingly, if, in connection with
the performance of services, vested contributions are made to a
trust on an individual's behalf and the trust assets may be
used solely to provide future payments to the individual, the
payment of the contributions to the trust constitutes a
transfer of property to the individual that is taxable under
section 83. On the other hand, deferred amounts are generally
not includible in income if nonqualified deferred compensation
is payable from general corporate funds that are subject to the
claims of general creditors, as such amounts are treated as
unfunded and unsecured promises to pay money or property in the
future.
---------------------------------------------------------------------------
\152\ Treas. Reg. sec. 1.83-3(e). This definition in part reflects
previous IRS rulings on nonqualified deferred compensation.
---------------------------------------------------------------------------
As discussed above, if the arrangement is unfunded, then
the compensation is generally includible in income when it is
actually or constructively received under section 451.\153\
Income is constructively received when it is credited to an
individual's account, set apart, or otherwise made available so
that it may be drawn on at any time. Income is not
constructively received if the taxpayer's control of its
receipt is subject to substantial limitations or restrictions.
A requirement to relinquish a valuable right in order to make
withdrawals is generally treated as a substantial limitation or
restriction.
---------------------------------------------------------------------------
\153\ Treas. Reg. secs. 1.451-1 and 1.451-2.
---------------------------------------------------------------------------
Rabbi trusts
Arrangements have developed in an effort to provide
employees with security for nonqualified deferred compensation,
while still allowing deferral of income inclusion. A ``rabbi
trust'' is a trust or other fund established by the employer to
hold assets from which nonqualified deferred compensation
payments will be made. The trust or fund is generally
irrevocable and does not permit the employer to use the assets
for purposes other than to provide nonqualified deferred
compensation, except that the terms of the trust or fund
provide that the assets are subject to the claims of the
employer's creditors in the case of insolvency or bankruptcy.
As discussed above, for purposes of section 83, property
includes a beneficial interest in assets set aside from the
claims of creditors, such as in a trust or fund, but does not
include an unfunded and unsecured promise to pay money in the
future. In the case of a rabbi trust, terms providing that the
assets are subject to the claims of creditors of the employer
in the case of insolvency or bankruptcy have been the basis for
the conclusion that the creation of a rabbi trust does not
cause the related nonqualified deferred compensation
arrangement to be funded for income tax purposes.\154\ As a
result, no amount is included in income by reason of the rabbi
trust; generally income inclusion occurs as payments are made
from the trust.
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\154\ This conclusion was first provided in a 1980 private ruling
issued by the IRS with respect to an arrangement covering a rabbi;
hence the popular name ``rabbi trust.'' Priv. Ltr. Rul. 8113107 (Dec.
31, 1980).
---------------------------------------------------------------------------
The IRS has issued guidance setting forth model rabbi trust
provisions.\155\ Revenue Procedure 92-64 provides a safe harbor
for taxpayers who adopt and maintain grantor trusts in
connection with unfunded deferred compensation arrangements.
The model trust language requires that the trust provide that
all assets of the trust are subject to the claims of the
general creditors of the company in the event of the company's
insolvency or bankruptcy.
---------------------------------------------------------------------------
\155\ Rev. Proc. 92-64, 1992-2 C.B. 422, modified in part by Notice
2000-56, 2000-2 C.B. 393.
---------------------------------------------------------------------------
Since the concept of rabbi trusts was developed,
arrangements have developed which attempt to protect the assets
from creditors despite the terms of the trust. Arrangements
also have developed which effectively allow deferred amounts to
be available to individuals, while still meeting the safe
harbor requirements set forth by the IRS.
REASONS FOR CHANGE
The report issued by the staff of the Joint Committee on
Taxation on their investigation of Enron Corporation,\156\
which was mandated by the Committee, detailed how executives
deferred millions of dollars in Federal income taxes through
nonqualified deferred compensation arrangements. Over $150
million in compensation was deferred by the 200-highest
compensated employees for the years 1998 through 2001.
---------------------------------------------------------------------------
\156\ Joint Committee on Taxation, Report of Investigation of Enron
Corporation and Related Entities Regarding Federal Tax and Compensation
Issues, and Policy Recommendations (JCS-3-03), February 2003.
---------------------------------------------------------------------------
The Committee is also aware of the popular use of deferred
compensation arrangements by executives of many other companies
to defer current taxation of substantial amounts of income. The
Committee believes that many nonqualified deferred compensation
arrangements have developed that allow improper deferral of
income. As in the case of Enron, executives often use
arrangements that allow deferral of income, but also provide
security of future payment to the executive. For example,
nonqualified deferred compensation arrangements often contain
provisions that allow participants to receive distributions
upon request, subject to forfeiture of a minimal amount (i.e.,
a ``haircut'' provision).
Since the concept of a rabbi trust was developed,
techniques have developed that attempt to protect the assets
from creditors despite the terms of the trust. For example, the
trust or fund may be located in a foreign jurisdiction, making
it difficult or impossible for creditors to reach the assets.
The Committee believes that certain arrangements that allow
participants inappropriate levels of control or access to
amounts deferred should not result in deferral of income
inclusion. The Committee also believes that certain
arrangements, such as offshore trusts, which effectively
protect assets from creditors, should be treated as funded and
not result in deferral of income inclusion.
The finding of the staff of Joint Committee on Taxation
support the Committee's views regarding the need for statutory
changes in the deferred compensation area.\157\ The Joint
Committee staff recommended changes to the present-law rules
regarding the taxation of nonqualified deferred compensation.
---------------------------------------------------------------------------
\157\ Id. at Vol. I, 592-637.
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EXPLANATION OF PROVISION
Under the provision, all amounts deferred under a
nonqualified deferred compensation plan \158\ for all taxable
years are currently includible in gross income to the extent
not subject to a substantial risk of forfeiture \159\ and not
previously included in gross income, unless certain
requirements are satisfied. If the requirements of the
provision are not satisfied, in addition to current income
inclusion, interest at the underpayment rate is imposed on the
underpayments that would have occurred had the compensation
been includible in income when first deferred, or if later,
when not subject to a substantial risk of forfeiture. In
addition, the amount required to be included in income is
subject to an additional ten percent tax. Actual or notional
earnings on amounts deferred are also subject to the provision.
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\158\ A plan includes an agreement or arrangement, including an
agreement or arrangement that includes one person.
\159\ As under section 83, the rights of a person to compensation
are subject to a substantial risk of forfeiture if the person's rights
to such compensation are conditioned upon the performance of
substantial services by any individual.
---------------------------------------------------------------------------
Under the provision, distributions from a nonqualified
deferred compensation plan may not be distributed earlier than
upon separation from service, death, a specified time (or
pursuant to a fixed schedule), change in control, occurrence of
an unforeseeable emergency, or if the participant becomes
disabled. A nonqualified deferred compensation plan may not
allow distributions other than upon the permissible
distribution events and may not permit the acceleration of the
time or schedule of any payment under the plan, except as
provided in regulations by the Secretary.
In the case of a specified employee, distributions upon
separation from service may not be made earlier than six months
after the date of the separation from service. Specified
employees are key employees (as defined in section 416(i)) of
publicly-traded corporations.
Amounts payable at a specified time or pursuant to a fixed
schedule must be specified under the plan at the time of
deferral. Amounts payable upon the occurrence of an event are
not treated as amounts payable at a specified time. For
example, amounts payable when an individual attains age 65 are
payable at a specified time, while amounts payable when an
individual's child begins college are payable upon the
occurrence of an event.
Distributions upon a change in the ownership or effective
control of a corporation, or in the ownership of a substantial
portion of the assets of a corporation, may only be made to the
extent provided by the Secretary. It is intended that the
Secretary use a similar, but more restrictive, definition of
change in control as used for purposes of the golden parachute
provisions of section 280G consistent with the purposes of the
provision. In the case of an individual who, with respect to a
corporation, is subject to the requirements of section 16(a) of
the Securities Act of 1934, distributions upon a change in
control may not be made earlier than one year after the date of
the change in control. Such individuals include officers (as
defined bysection 16(a)),\160\ directors, or 10-percent owners
of publicly-held corporations. Under the provision, distributions made
to such individuals within one year of the change in control
(``applicable payments'') are treated as excess parachute payments
under section 280G (even if the payment would not otherwise be treated
as an excess parachute payment) and therefore subject to the excise tax
under section 4999. As under present law, no deduction is allowed for
any amount treated as an excess parachute payment.
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\160\ An officer is defined as the president, principal financial
officer, principal accounting officer (or, if there is no such
accounting officer, the controller), any vice-president in charge of a
principal business unit, division or function (such as sales,
administration or finance), any other officer who performs a policy-
making function, or any other person who performs similar policy-making
functions.
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If, absent the provision, an applicable payment is a
payment in the nature of compensation contingent on a change in
control, section 280G shall be applied as if the provision had
not been enacted (i.e., the applicable payments shall continue
to be taken into account under section 280G). Any resulting
excess parachute payment also shall be subject to the excise
tax under section 4999 (in addition to the tax imposed by the
provision). Under the provision, an applicable payment that,
absent the provision, is not a payment in the nature of
compensation contingent on a change in control is required to
be taken into account in determining if the present value of
the payments in the nature of compensation contingent on a
change in control equal or exceed three times the base amount.
Any resulting excess parachute payment also shall be subject to
the excise tax under section 4999 (in addition to the tax
imposed by the provision). Applicable payments do not include
payments made upon death or if the participant becomes
disabled. Treasury regulations shall prescribe rules to prevent
a deduction from being disallowed more than once.
Unforeseeable emergency is defined as severe financial
hardship of the participant or beneficiary resulting from a
sudden and unexpected illness or accident of the participant or
beneficiary, the participant's or beneficiary's spouse or the
participant's or beneficiary's dependent (as defined in
152(a)); loss of the participant's or beneficiary's property
due to casualty; or other similar extraordinary and
unforeseeable circumstances arising as a result of events
beyond the control of the participant or beneficiary. The
amount of the distribution must be limited to the amount needed
to satisfy the emergency plus taxes. Distributions can not be
allowed to the extent that the hardship may be relieved through
reimbursement or compensation by insurance or otherwise, or by
liquidation of the participant's or beneficiary's assets (to
the extent such liquidation would not itself cause severe
financial hardship).
A participant is considered disabled if he or she (i) is
unable to engage in any substantial gainful activity by reason
of any medically determinable physical or mental impairment
which can be expected to result in death or can be expected to
last for a continuous period of not less than 12 months; or
(ii) is, by reason on any medically determinable physical or
mental impairment which can be expected to result in death or
can be expected to last for a continuous period of not less
than 12 months, receiving income replacement benefits for a
period of not less than three months under an accident and
health plan covering employees of the individual's employer.
Under the provision, investment options (including phantom
or notional investment options) which a participant may elect
under the nonqualified deferred compensation plan must be
comparable to those which may be elected by participants of the
qualified defined contribution plan of the employer that has
the fewest investment options. It is intended that the
investment options of the nonqualified deferred compensation
plan may be less favorable or more limited than those of the
qualified defined contribution employer plan. The Committee
intends that open brokerage windows, hedge funds, and
investments in which the employer guarantees a rate of return
above what is commercially available are prohibited. If there
is no qualified defined contribution employer plan, the
investment options of the nonqualified deferred compensation
plan must meet the requirements prescribed by the Secretary
regarding permissible investment options. It is intended that
in cases where there is no such qualified defined contribution
employer plan, the Secretary issue rules limiting the available
investment options.
The provision requires that the plan must provide that
compensation for services performed during a taxable year may
be deferred at the participant's election only if the election
to defer is made no later than during the preceding taxable
year, or at such other time as provided in Treasury
regulations. In the first year that an employee becomes
eligible for participation in a nonqualified deferred
compensation plan, the election may be made within 30 days
after the date that the employee is initially eligible.
Under the provision, a plan may allow changes in the time
and form of distributions subject to certain requirements. A
nonqualified deferred compensation plan may allow subsequent
elections to delay the timing or form of distributions only if
(1) the plan requires that the election may not take effect
until at least 12 months after the date on which the election
is made; (2) except in the case of elections relating to
disability, death, or unforeseeable emergency, the plan
requires that the first payments with respect to which such
election is made be deferred for a period of not less than 5
years from the date such payment would otherwise have been
made; and (3) the plan requires that any election related to a
payment upon a specified time may not be made less than 12
months prior to the date of the first scheduled payment. An
individual cannot be permitted to make more than one subsequent
election with respect to an amount deferred. As previously
discussed, no accelerations of distributions may be allowed
(except as provided in regulations by the Secretary). For
example, changes in the form of a distribution from an annuity
to a lump sum are not permitted.
If impermissible distributions or elections are made, or if
the nonqualified deferred compensation plan allows
impermissible distributions or elections, all amounts deferred
under the plan (including amounts deferred in prior years) are
currently includible in income to the extent not subject to a
substantial risk of forfeiture and not previously included in
income. In addition, interest at the underpayment rate is
imposed on the underpayments that would have occurred had the
compensation been includible in income when first deferred, or
if later, when not subject to a substantial risk of forfeiture.
An additional ten percent tax also applies to the amount
required to be included in income.
Under the provision, assets set aside (directly or
indirectly) in a trust (or other similar arrangement) for the
purpose of paying nonqualified deferred compensation are
treated as property transferred in connection with the
performance of services under section 83 (whether or not such
assets are available to satisfy the claims of general
creditors) (1) at the time set aside ifsuch assets are located
outside of the United States, or (2) at the time transferred if such
assets are subsequently transferred outside of the United States. Any
increases in the value of, or any earnings with respect to, such assets
are treated as additional transfers of property. Interest at the
underpayment rate is imposed on the underpayments that would have
occurred had the amounts been includible in income for the taxable year
in which first deferred or, if later, the first taxable year in which
such amounts are not subject to a substantial risk of forfeiture. The
amount required to be included in income is also subject to an
additional ten percent tax. The provision does not apply to assets
located in a foreign jurisdiction if substantially all of the services
to which the nonqualified deferred compensation relates are performed
in such foreign jurisdiction. The provision is specifically intended to
apply to foreign trusts and arrangements that effectively shield from
the claims of general creditors any assets intended to satisfy
nonqualified deferred compensation arrangements. The Secretary has
authority to exempt arrangements from the provision if the arrangements
do not result in an improper deferral of U.S. tax and will not result
in assets being effectively beyond the reach of creditors.
Under the provision, a transfer of property in connection
with the performance of services under section 83 also occurs
if a nonqualified deferred compensation plan provides that,
upon a change in the employer's financial health, assets will
be restricted to the payment of nonqualified deferred
compensation. The transfer of property occurs as of the earlier
of when the assets are so restricted or when the plan provides
that assets will be restricted. Any increases in the value of,
or any earnings with respect to, such assets are treated as
additional transfers of property. Interest at the underpayment
rate is imposed on the underpayments that would have occurred
had the amounts been includible in income for the taxable year
in which first deferred or, if later, the first taxable year in
which such amounts are not subject to a substantial risk of
forfeiture. The amount required to be included in income is
also subject to an additional ten percent tax.
A nonqualified deferred compensation plan is any plan that
provides for the deferral of compensation other than a
qualified employer plan or any bona fide vacation leave, sick
leave, compensatory time, disability pay, or death benefit
plan. A qualified employer plan means a qualified retirement
plan, tax-deferred annuity, simplified employee pension, and
SIMPLE.\161\ A governmental eligible deferred compensation plan
(sec. 457) is also a qualified employer plan under the
provision.
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\161\ A qualified employer plan also includes a section 501(c)(18)
trust.
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Interest imposed under the provision is treated as interest
on an underpayment of tax. Income (whether actual or notional)
attributable to nonqualified deferred compensation is treated
as additional deferred compensation and is subject to the
provision. The provision does not prevent the inclusion of
amounts in gross income under any provision or rule of law
earlier than the time provided in the provision. Any amount
required to be included in gross income under the provision
shall not be required to be included in gross income under any
other rule of law later than the time provided in the
provision. The provision does not affect the rules regarding
the timing of an employer's deduction for nonqualified deferred
compensation.
The provision requires annual reporting to the IRS of
amounts deferred. Such amounts are required to be reported on
an individual's Form W-2 for the year deferred even if the
amount is not currently includible in income for that taxable
year. Under the provision, the Secretary is authorized, through
regulations, to establish a minimum amount of deferrals below
which the reporting requirements do not apply.
The provision provides the Secretary of the Treasury
authority to prescribe regulations as are necessary to carry
out the purposes of provision, including regulations: (1)
providing for amounts of deferral in the case of defined
benefit plans; (2) relating to changes in the ownership and
control of a corporation or assets of a corporation; (3)
exempting from the provisions providing for transfers of
property arrangements that will not result in an improper
deferral of U.S. tax and will not result in assets being
effectively beyond the reach of creditors; (4) defining
financial health; and (5) disregarding a substantial risk of
forfeiture in cases where necessary to carry out the purposes
of the provision.
It is intended that substantial risk of forfeitures may not
be used to manipulate the timing of income inclusion. It is
intended that substantial risks of forfeiture should be
disregarded in cases in which they are illusory or are
principally used to postpone the timing of income inclusion.
For example, if an executive is effectively able to control the
acceleration of the lapse of a substantial risk of forfeiture,
such risk of forfeiture should be disregarded and income
inclusion should not be postponed on account of such
restriction.
EFFECTIVE DATE
The provision is effective for amounts deferred in taxable
years beginning after December 31, 2004.
The provision applies to earnings on deferred compensation
only to the extent that the provision applies to such
compensation.
Not later than 90 days after the date of enactment, the
Secretary is directed to issue guidance on what constitutes a
change in ownership or effective control.
Not later than 90 days after the date of enactment, the
Secretary is directed to issue guidance providing a limited
period during which an individual participating in a
nonqualified deferred compensation plan adopted before December
31, 2004, may, without violating the provision, terminate
participation or cancel an outstanding deferral election with
regard to amounts earned after December 31, 2004, if such
amounts are includible in income as earned.
C. Denial of Deferral of Certain Stock Option and Restricted Stock
Gains
(Sec. 503 of the bill and sec. 63 of the Code)
PRESENT LAW
Section 83 applies to transfers of property in connection
with the performance of services. Under section 83, if, in
connection with the performance of services, property is
transferred to any person other than the person for whom such
services are performed, the excess of the fair market value of
such property over the amount (if any) paid for the property is
includible in income at the first time that the property is
transferable or not subject to substantial risk of forfeiture.
Stock granted to an employee (or other service provider) is
subject to the rules that apply under section 83. When stock is
vested and transferred to an employee, the excess of the fair
market value of the stock over the amount, if any, the employee
pays for the stock is includible in the employee's income for
the year in which the transfer occurs.
The income taxation of a nonqualified stock option is
determined under section 83 and depends on whether the option
has a readily ascertainable fair market value. If the
nonqualified option does not have a readily ascertainable fair
market value at the time of grant, no amount is includible in
the gross income of the recipient with respect to the option
until the recipient exercises the option. The transfer of stock
on exercise of the option is subject to the general rules of
section 83. That is, if vested stock is received on exercise of
the option, the excess of the fair market value of the stock
over the option price is includible in the recipient's gross
income as ordinary income in the taxable year in which the
option is exercised. If the stock received on exercise of the
option is not vested, the excess of the fair market value of
the stock at the time of vesting over the option price is
includible in the recipient's income for the year in which
vesting occurs unless the recipient elects to apply section 83
at the time of exercise.
Other forms of stock-based compensation are also subject to
the rules of section 83.
REASONS FOR CHANGE
The Committee is aware of the use of certain programs that
allow executives to defer taxes attributable to stock option
gains and restricted stock gains by exchanging their interest
in the property for a future payment of such gain. The report
issued by the staff of the Joint Committee on Taxation on their
investigation of Enron Corporation,\162\ which was mandated by
the Committee, showed that executives at Enron Corporation
deferred Federal income taxes under such programs. The
Committee does not believe that such practices should be
allowed to continue as they result in inappropriate deferred
income.
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\162\ Joint Committee on Taxation, Report of Investigation of Enron
Corporation and Related Entities Regarding Federal Tax and Compensation
Issues, and Policy Recommendations (JCS-3-03), February 2003.
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EXPLANATION OF PROVISION
Under the provision, gains attributable to stock options
(including exercises of stock options), vesting of restricted
stock, and other compensation based on employer securities
(including employer securities) cannot be deferred by
exchanging such amounts for a right to receive a future
payment. Except as provided by the Secretary, if a taxpayer
exchanges (1) an option to purchase employer securities, (2)
employer securities, or (3) any other property based on
employer securities for a right to receive future payments, an
amount equal to the present value of such right (or such other
amount as the Secretary specifies) is required to be included
in gross income for the taxable year of the exchange. The
provision applies even if the future right to payment is
treated as an unfunded and unsecured promise to pay. The
provision applies when there is in substance an exchange, even
if the transaction is not formally structured as an exchange.
The provision is not intended to imply that such practices
result in permissive deferral of income under present law.
EFFECTIVE DATE
The provision applies to exchanges after December 31, 2004.
D. Increase in Withholding From Supplemental Wage Payments in Excess of
$1 Million
(Sec. 504 of the bill and sec. 13273 of the Revenue Reconciliation Act
of 1993)
PRESENT LAW
An employer must withhold income taxes from wages paid to
employees; there are several possible methods for determining
the amount of income tax to be withheld. The IRS publishes
tables (Publication 15, ``Circular E'') to be used in
determining the amount of income tax to be withheld. The tables
generally reflect the income tax rates under the Code so that
withholding approximates the ultimate tax liability with
respect to the wage payments. In some cases, ``supplemental''
wage payments (e.g., bonuses or commissions) may be subject to
withholding at a flat rate,\163\ based on the third lowest
income tax rate under the Code (25 percent for 2004).\164\
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\163\ Sec. 13273 of the Revenue Reconciliation Act of 1993.
\164\ Sec. 101(c)(11) of the Economic Growth and Tax Relief
Reconciliation Act of 2001.
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REASONS FOR CHANGE
The Committee believes that because most employees who
receive annual supplemental wage payments in excess of $1
million will ultimately be taxed at the highest marginal rate,
it is appropriate to raise the withholding rate on such
payments so that withholding more closely approximates the
ultimate tax liability with respect to these payments.
EXPLANATION OF PROVISION
Under the provision, once annual supplemental wage payments
to an employee exceed $1 million, any additional supplemental
wage payments to the employee in that year are subject to
withholding at the highest income tax rate (35 percent for
2004), regardless of any other withholding rules and regardless
of the employee's Form W-4.
This rule applies only for purposes of wage withholding;
other types of withholding (such as pension withholding and
backup withholding) are not affected.
EFFECTIVE DATE
The provision is effective with respect to payments made
after December 31, 2003.
E. Exclusion of Incentive Stock Options and Employee Stock Purchase
Plan Stock Options From Wages
(Sec. 511 of the bill and secs. 421(b), 423(c), 3121(a), 3231, and
3306(b) of the Code)
PRESENT LAW
Generally, when an employee exercises a compensatory option
on employer stock, the difference between the option price and
the fair market value of the stock (i.e., the ``spread'') is
includible in income as compensation. In the case of an
incentive stock option or an option to purchase stock under an
employee stock purchase plan (collectively referred to as
``statutory stock options''), the spread is not included in
income at the time of exercise.\165\
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\165\ Sec. 421.
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If the statutory holding period requirements are satisfied
with respect to stock acquired through the exercise of a
statutory stock option, the spread, and any additional
appreciation, will be taxed as capital gain upon disposition of
such stock. Compensation income is recognized, however, if
there is a disqualifying disposition (i.e., if the statutory
holding period is not satisfied) of stock acquired pursuant to
the exercise of a statutory stock option.
Federal Insurance Contribution Act (``FICA'') and Federal
Unemployment Tax Act (``FUTA'') taxes (collectively referred to
as ``employment taxes'') are generally imposed in an amount
equal to a percentage of wages paid by the employer with
respect to employment.\166\ The applicable Code provisions
\167\ do not provide an exception from FICA and FUTA taxes for
wages paid to an employee arising from the exercise of a
statutory stock option.
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\166\ Secs. 3101, 3111 and 3301.
\167\ Secs. 3121 and 3306.
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There has been uncertainty in the past as to employer
withholding obligations upon the exercise of statutory stock
options. On June 25, 2002, the IRS announced in Notice 2002-47
\168\ that until further guidance is issued, it would not
assess FICA or FUTA taxes, or impose Federal income tax
withholding obligations, upon either the exercise of a
statutory stock option or the disposition of the stock acquired
pursuant to the exercise of a statutory stock option.
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\168\ Notice 2002-47, 2002-28 I.R.B. 97.
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REASONS FOR CHANGE
The Committee believes that it is appropriate to clarify
statutorily the treatment of statutory stock options for
employment tax and income tax withholding purposes. The
Committee believes that it is appropriate to provide specific
exclusions from withholding requirements for wages attributable
to statutory stock options.
EXPLANATION OF PROVISION
The provision provides specific exclusions from FICA and
FUTA wages for remuneration on account of the transfer of stock
pursuant to the exercise of an incentive stock option or under
an employee stock purchase plan, or any disposition of such
stock. Thus, under the provision, FICA and FUTA taxes do not
apply upon the exercise of a statutory stock option.\169\ The
provision also provides that such remuneration is not taken
into account for purposes of determining Social Security
benefits.
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\169\ The provision also provides a similar exclusion for wages
under the Railroad Retirement Tax Act.
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Additionally, the provision provides that Federal income
tax withholding is not required on a disqualifying disposition,
nor when compensation is recognized in connection with an
employee stock purchase plan discount. Present law reporting
requirements continue to apply.
EFFECTIVE DATE
The provision is effective on the date of enactment.
F. Capital Gain Treatment on Sale of Stock Acquired From Exercise of
Statutory Stock Options To Comply With Conflict of Interest
Requirements
(Sec. 512 of the bill and sec. 421 of the Code)
PRESENT LAW
Statutory stock options
Generally, when an employee exercises a compensatory option
on employer stock, the difference between the option price and
the fair market value of the stock (i.e., the ``spread'') is
includible in income as compensation. Upon such exercise, an
employer is allowed a corresponding compensation deduction. In
the case of an incentive stock option or an option to purchase
stock under an employee stock purchase plan (collectively
referred to as ``statutory stock options''), the spread is not
included in income at the time of exercise.\170\
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\170\ Sec. 421.
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If an employee disposes of stock acquired upon the exercise
of a statutory option, the employee generally is taxed at
capital gains rates with respect to the excess of the fair
market value of the stock on the date of disposition over the
option price, and no compensation expense deduction is
allowable to the employer, unless the employee fails to meet a
holding period requirement. The employee fails to meet this
holding period requirement if the disposition occurs within two
years after the date the option is granted or one year after
the date the option is exercised. The gain upon a disposition
that occurs prior to the expiration of the applicable holding
period(s) (a ``disqualifying disposition'') does not qualify
for capital gains treatment. In the event of a disqualifying
disposition, the income attributable to the disposition is
treated by the employee as income received in the taxable year
in which the disposition occurs, and a corresponding deduction
is allowable to the employer for the taxable year in which the
disposition occurs.
Sale of property to comply with conflict of interest requirements
The Code provides special rules for recognizing gain on
sales of property which are required in order to comply with
certain conflict of interest requirements imposed by the
Federal Government.\171\ Certain executive branch Federal
employees (and their spouses and minor or dependent children)
who are required to divest property in order to comply with
conflict of interest requirements may elect to postpone the
recognition of resulting gains by investing in certain
replacement property within a 60-day period. The basis of the
replacement property is reduced by the amount of the gain not
recognized. Permitted replacement property is limited to any
obligation of the United States or any diversified investment
fund approved by regulations issued by the Office of Government
Ethics. The rule applies only to sales under certificates of
divestiture issued by the President or the Director of the
Office of Government Ethics.
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\171\ Sec. 1043.
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REASONS FOR CHANGE
To comply with Federal conflict of interest requirements,
executive branch personnel may be required, before the
statutory holding period requirements have been satisfied, to
divest holdings of stock acquired pursuant to the exercise of
statutory stock options. Because Federal conflict of interest
requirements mandate the sale of such shares, the Committee
believes that such individuals should be afforded the tax
treatment that would be allowed had the individual held the
stock for the required holding period.
EXPLANATION OF PROVISION
Under the provision, an eligible person who, in order to
comply with Federal conflict of interest requirements, is
required to sell shares of stock acquired pursuant to the
exercise of a statutory stock option is treated as satisfying
the statutory holding period requirements, regardless of how
long the stock was actually held. An eligible person generally
includes an officer or employee of the executive branch of the
Federal Government (and any spouse or minor or dependent
children whose ownership in property is attributable to the
officer or employee). Because the sale is not treated as a
disqualifying disposition, the individual is afforded capital
gain treatment on any resulting gains. Such gains are eligible
for deferral treatment under section 1043.
The employer granting the option is not allowed a deduction
upon the sale of the stock by the individual.
EFFECTIVE DATE
The provision is effective for sales after the date of
enactment.
TITLE VI. WOMEN'S PENSION PROTECTION
A. Study of Spousal Consent for Distributions From Defined Contribution
Plans
(Sec. 601 of the bill)
PRESENT LAW
Qualified retirement plans are generally subject to
requirements regarding the form in which benefits may be paid
without spousal consent.\172\ The extent to which the
requirements apply depends on the type of plan.
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\172\ Code secs. 401(a)(11) and 417; ERISA sec. 205.
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Defined benefit pension plans and money purchase pension
plans \173\ are generally required to provide benefits in the
form of a qualified joint and survivor annuity (``QJSA'')
unless the participant and his or her spouse consent to another
form of benefit. A QJSA is an annuity for the life of the
participant, with a survivor annuity for the life of the spouse
that is not less than 50 percent (and not more than 100
percent) of the amount of the annuity payable during the joint
lives of the participant and his or her spouse. In addition, if
a married participant dies before the commencement of
retirement benefits, the surviving spouse must be provided with
a qualified preretirement survivor annuity (``QPSA''), which
generally must provide the surviving spouse with a benefit that
is not less than the benefit that would have been provided
under the survivor portion of a QJSA.\174\
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\173\ A money purchase pension plan is a type of defined
contribution plan that provides for a set level of required employer
contributions, generally as a specified percentage of participants'
compensation, and for the distribution of benefits in the form of an
annuity.
\174\ In the case of a money purchase pension plan, a QPSA means an
annuity for the life of the surviving spouse that has an actuarial
value of at least 50 percent of the participant's vested account
balance as of the date of death.
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The participant and his or her spouse may waive the right
to a QJSA and QPSA if certain requirements are satisfied. In
general, these requirements include providing the participant
with a written explanation of the terms and conditions of the
survivor annuity, the right to make, and the effect of, a
waiver of the annuity, the rights of the spouse to waive the
survivor annuity, and the right of the participant to revoke
the waiver. In addition, the spouse must provide a written
consent to the waiver, witnessed by a plan representative or a
notary public, which acknowledges the effect of the waiver.
Defined contribution plans other than money purchase
pension plans are generally not subject to the QJSA and QPSA
rules unless the plan offers benefits in the form of an annuity
and the participant elects an annuity. However, such defined
contribution plans must provide that the participant's
surviving spouse is the beneficiary of the participant's entire
vested account balance under the plan, unless the spouse
consents to designation of another beneficiary. In addition,
the plan must not have received a transfer of assets from a
plan to which the QJSA and QPSA requirements applied or must
separately account for the transferred assets.
REASONS FOR CHANGE
Present law requires defined benefit pension plans and
money purchase pension plans to provide annuity benefits to a
participant's surviving spouse unless the spouse consents to
waive the annuity. The spousal consent rules provide important
protections for spouses, particularly nonworking spouses. These
rules also assist married employees and their spouses in
determining how to meet their retirement income needs by
requiring distributions in the form of a QJSA unless the
participant and spouse consent to another form.
Most defined contribution plans do not offer benefits in
the form of an annuity and thus are not subject to the QJSA and
QPSA rules under present law. Requiring such plans to offer
annuities (unless the participant and spouse elect otherwise)
represents a significant policy change and is likely to
increase administrative burdens for such plans. However, for
many employees, a defined contribution plan is the only type of
retirement plan offered by their employer. The Committee
believes a study should be conducted on the feasibility and
desirability of extending the spousal consent requirements to
defined contribution plans.
EXPLANATION OF PROVISION
The Secretary of Labor and the Secretary of Treasury are
required to conduct a joint study of the feasibility and
desirability of extending the spousal consent requirements to
defined contribution plans to which the requirements do not
apply under present law and to report the results thereof, with
recommendations for legislative changes, within two years after
the date of enactment, to the House Committees on Ways and
Means and on Education and the Workforce and the Senate
Committees on Finance and on Health, Education, Labor and
Pensions. In conducting the study, the Secretary of Labor and
the Secretary of Treasury are required to consider: (1) any
modifications of the spousal consent requirements that are
necessary to apply the requirements to defined contribution
plans; and (2) the feasibility of providing notice and spousal
consent in electronic form that are capable of authentication.
EFFECTIVE DATE
The provision is effective on the date of enactment.
B. Division of Pension Benefits Upon Divorce
(Sec. 611 of the bill)
PRESENT LAW
Benefits provided under a qualified retirement plan for a
participant may not be assigned or alienated to creditors of
the participant, except in very limited circumstances.\175\ One
exception to the prohibition on assignment or alienation is a
qualified domestic relations order (``QDRO'').\176\ A QDRO is a
domestic relations order that creates or recognizes a right of
an alternate payee, including a former spouse, to any plan
benefit payable with respect to a participant and that meets
certain procedural requirements. In addition, a QDRO generally
may not require the plan to provide any type or form of
benefit, or any option, not otherwise provided under the plan,
or to provide increased benefits.
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\175\ Code sec. 401(a)(13); ERISA sec. 206(d).
\176\ Code secs. 401(a)(13)(B) and 414(p); ERISA sec. 206(d)(3).
---------------------------------------------------------------------------
Present law also provides that a QDRO may not require the
payment of benefits to an alternate payee that are required to
be paid to another alternate payee under a domestic relations
order previously determined to be a QDRO. This rule implicitly
recognizes that a domestic relations order issued after a QDRO
may also qualify as a QDRO. However, present law does not
otherwise provide specific rules for the treatment of a
domestic relations order as a QDRO if the order is issued after
another domestic relations order or a QDRO (including an order
issued after a divorce decree) or revises another domestic
relations order or a QDRO.
Present law provides specific rules that apply during any
period in which the status of a domestic relations order as a
QDRO is being determined (by the plan administrator, by a
court, or otherwise). During such a period, the plan
administrator is required to account separately for the amounts
that would have been payable to the alternate payee during the
period if the order had been determined to be a QDRO (referred
to as ``segregated amounts''). If, within the 18-month period
beginning with the date on which the first payment would be
required to be made under the order, the order (or modification
thereof) is determined to be a QDRO, the plan administrator is
required to pay the segregated amounts (including any interest
thereon) to the person or persons entitled thereto. If, within
the 18-month period, the order is determined not to be a QDRO,
or its status as a QDRO is not resolved, the plan administrator
is required to pay the segregated amounts (including any
interest) to the person or persons who would be entitled to
such amounts if there were no order. In such a case, any
subsequent determination that the order is a QDRO is applied
prospectively only.
REASONS FOR CHANGE
The Committee understands that uncertainty exists under
present law as to the treatment of certain domestic relations
orders as QDROs, such as those that are issued subsequent to
divorce or that revise a previous domestic relations order or
QDRO. The Committee understands that issues as to whether a
subsequent domestic relations order is a QDRO have arisen even
in cases involving the same former spouse, such as a domestic
relations order that deals with benefits not dealt with in a
QDRO previously issued to the same former spouse. The Committee
believes the treatment of such domestic relations orders should
be clarified.
EXPLANATION OF PROVISION
The Secretary of Labor is directed to issue, not later than
one year after the date of enactment of the provision,
regulations to clarify the status of certain domestic relations
orders. In particular, the regulations are to clarify that a
domestic relations order otherwise meeting the QDRO
requirements will not fail to be treated as a QDRO solely
because of the time it is issued or because it is issued after
or revises another domestic relations order or another QDRO.
The regulations are also to clarify that such a domestic
relations order is in all respects subject to the same
requirements and protections that apply to QDROs. For example,
as under present law, such a domestic relations order may not
require the payment of benefits to an alternate payee that are
required to be paid to another alternate payee under an earlier
QDRO. In addition, the present-law rules regarding segregated
amounts that apply while the status of a domestic relations
order as a QDRO is being determined continue to apply.
EFFECTIVE DATE
The provision is effective on the date of enactment.
C. Protection of Rights of Former Spouses Under the Railroad Retirement
System
(Secs. 621 and 622 of the Act and secs. 2 and 5 of the Railroad
Retirement Act of 1974)
PRESENT LAW
In general
The Railroad Retirement System has two main components.
Tier I of the system is financed by taxes on employers and
employees equal to the Social Security payroll tax and provides
qualified railroad retirees (and their qualified spouses,
dependents, widows, or widowers) with benefits that are roughly
equal to Social Security. Covered railroad workers and their
employers pay the Tier I tax instead of the Social Security
payroll tax, and most railroad retirees collect Tier I benefits
instead of Social Security. Tier II of the system replicates a
private pension plan, with employers and employees contributing
a certain percentage of pay toward the system to finance
defined benefits to eligible railroad retirees (and qualified
spouses, dependents, widows, or widowers) upon retirement;
however, the Federal Government collects the Tier II payroll
contribution and pays out the benefits.
Former spouses of living railroad employees
Generally, a former spouse of a railroad employee who is
otherwise eligible for any Tier I or Tier II benefit cannot
receive either benefit until the railroad employee actually
retires and begins receiving his or her retirement benefits.
This is the case regardless of whether a State divorce court
has awarded such railroad retirement benefits to the former
spouse.
Former spouses of deceased railroad employees
The former spouse of a railroad employee may be eligible
for survivors benefits under Tier I of the Railroad Retirement
System. However, a former spouse loses eligibility for any
otherwise allowable Tier II benefits upon the death of the
railroad employee.
REASONS FOR CHANGE
The Committee wishes to provide more equitable treatment of
former spouses of railroad employees.
EXPLANATION OF PROVISION
Former spouses of living railroad employees
The bill eliminates the requirement that a railroad
employee actually receive railroad retirement benefits for the
former spouse to be entitled to any Tier I benefit or Tier II
benefit awarded under a State divorce court decision.
Former spouses of deceased railroad employees
The bill provides that a former spouse of a railroad
employee does not lose eligibility for otherwise allowable Tier
II benefits upon the death of the railroad employee.
EFFECTIVE DATE
The railroad retirement provisions are effective one year
after the date of enactment.
D. Modifications of Joint and Survivor Annuity Requirements
(Sec. 631 of the bill and secs. 401 and 417 of the Code and sec. 205 of
ERISA)
PRESENT LAW
Defined benefit pension plans and money purchase pension
plans are required to provide benefits in the form of a
qualified joint and survivor annuity (``QJSA'') unless the
participant and his or her spouse consent to another form of
benefit.\177\ A QJSA is an annuity for the life of the
participant, with a survivor annuity for the life of the spouse
which is not less than 50 percent (and not more than 100
percent) of the amount of the annuity payable during the joint
lives of the participant and his or her spouse.\178\ In the
case of a married participant who dies before the commencement
of retirement benefits, the surviving spouse must be provided
with a qualified preretirement survivor annuity (``QPSA''),
which must provide the surviving spouse with a benefit that is
not less than the benefit that would have been provided under
the survivor portion of a QJSA.
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\177\ Code secs. 401(a)(11) and 417; ERISA sec. 205.
\178\ Thus, a plan could provide an annuity for the life of the
participant, with a survivor annuity for the life of the spouse equal
to 75 percent of the amount of the annuity payable during the joint
lives of the participant and his or her spouse.
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The participant and his or her spouse may waive the right
to a QJSA and QPSA provided certain requirements are satisfied.
In general, these conditions include providing the participant
with a written explanation of the terms and conditions of the
survivor annuity, the right to make, and the effect of, a
waiver of the annuity, the rights of the spouse to waive the
survivor annuity, and the right of the participant to revoke
the waiver. In addition, the spouse must provide a written
consent to the waiver, witnessed by a plan representative or a
notary public, which acknowledges the effect of the waiver.
Defined contribution plans other than money purchase
pension plans are not required to provide a QJSA or QPSA if the
participant does not elect an annuity as the form of payment,
the surviving spouse is the beneficiary of the participant's
entire vested account balance under the plan (unless the spouse
consents to designation of another beneficiary),\179\ and, with
respect to the participant, the plan has not received a
transfer from a plan to which the QJSA and QPSA requirements
applied (or separately accounts for the transferred assets). In
the case of a defined contribution plan subject to the QJSA and
QPSA requirements, a QPSA means an annuity for the life of the
surviving spouse that has an actuarial value of at least 50
percent of the participant's vested account balance as of the
date of death.
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\179\ Waiver and election rules apply to the waiver of the right of
the spouse to be the beneficiary under a defined contribution plan that
is not required to provide a QJSA.
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REASONS FOR CHANGE
The Committee believes that it is appropriate to allow
participants greater choice in selecting their form of
benefits. The Committee believes that participants should have
moreoptions regarding their form of benefits so that they can
determine the most appropriate option depending on the participant's
individual circumstances. For example, some couples may prefer an
option that pays a smaller benefit to the couple while they are both
alive with a larger benefit to the surviving spouse.
EXPLANATION OF PROVISION
The provision revises the minimum survivor annuity
requirements to require that, at the election of the
participant, benefits will be paid in the form of a ``qualified
optional survivor annuity.'' A qualified optional survivor
annuity means an annuity for the life of the participant with a
survivor annuity for the life of the spouse which is equal to
the applicable percentage of the amount of the annuity which is
payable during the joint lives of the participant and the
spouse and which is the actuarial equivalent of a single
annuity for the life of the participant.
If the survivor annuity under plan's qualified joint and
survivor annuity is less than 75 percent of the annuity payable
during the joint lives of the participant and spouse, the
applicable percentage is 75 percent. If the survivor annuity
under plan's qualified joint and survivor annuity is greater
than or equal to 75 percent of the annuity payable during the
joint lives of the participant and spouse, the applicable
percentage is 50 percent. Thus, for example, if the survivor
annuity under the plan's qualified joint and survivor annuity
is 50 percent, the survivor annuity under the qualified
optional survivor annuity must be 75 percent.
The written explanation required to be provided to
participants explaining the terms and conditions of the
qualified joint and survivor annuity must also include the
terms and conditions of the qualified optional survivor
annuity.
Under the provision of the bill relating to plan
amendments, a plan amendment made pursuant to a provision of
the bill generally will not violate the anticutback rule if
certain requirements are met (e.g., the plan amendment is made
on or before the last day of the first plan year beginning on
or after January 1, 2006). Thus, a plan is not treated as
having decreased the accrued benefit of a participant solely by
reason of the adoption of a plan amendment pursuant to the
provision requiring that the plan offer a qualified optional
survivor annuity. The elimination of a subsidized qualified
joint and survivor annuity is not protected by the anticutback
provision in the bill unless an equivalent or greater subsidy
is retained in one of the forms offered under the plan as
amended. For example, if a plan that offers a subsidized 50
percent qualified joint and survivor annuity is amended to
provide an unsubsidized 50 percent qualified joint and survivor
annuity and an unsubsidized 75 percent joint and survivor
annuity as its qualified optional survivor annuity, the
replacement of the subsidized 50 percent qualified joint and
survivor annuity with the unsubsidized 50 percent qualified
joint and survivor annuity is not protected by the anticutback
protection.
EFFECTIVE DATE
The provision applies generally to plan years beginning
after December 31, 2004. In the case of a plan maintained
pursuant to one or more collective bargaining agreements, the
provision applies to plan years beginning on or after the
earlier of (1) the later of January 1, 2005, and the last date
on which an applicable collective bargaining agreement
terminates (without regard to extensions), and (2) January 1,
2006.
TITLE VII. TAX COURT PENSION AND COMPENSATION MODERNIZATION
A. Judges of the Tax Court
(Secs. 701-707 and 713 of the bill and secs. 7443, 7447, 7448, and 7472
of the Code)
PRESENT LAW
The Tax Court is established by the Congress pursuant to
Article I of the U.S. Constitution.\180\ The salary of a Tax
Court judge is the same salary as received by a U.S. District
Court judge.\181\ Present law also provides Tax Court judges
with some benefits that correspond to benefits provided to U.S.
District Court judges, including specific retirement and
survivor benefit programs for Tax Court judges.\182\
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\180\ Sec. 7441.
\181\ Sec. 7443(c).
\182\ Secs. 7447 and 7448.
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Under the retirement program, a Tax Court judge may elect
to receive retirement pay from the Tax Court in lieu of
benefits under another Federal retirement program. A Tax Court
judge may also elect to participate in a plan providing annuity
benefits for the judge's surviving spouse and dependent
children (the ``survivors' annuity plan''). Generally, benefits
under the survivors' annuity plan are payable only if the judge
has performed at least five years of service. Cost-of-living
increases in benefits under the survivors' annuity plan are
generally based on increases in pay for active judges.
Tax Court judges participate in the Federal Employees Group
Life Insurance program (the ``FEGLI'' program). Retired Tax
Court judges are eligible to participate in the FEGLI program
as the result of an administrative determination of their
eligibility, rather than a specific statutory provision.
Tax Court judges are not covered by the leave system for
Federal executive branch employees. As a result, an individual
who works in the Federal executive branch before being
appointed to the Tax Court does not continue to accrue annual
leave under the same leave program and may not use leave
accrued prior to his or her appointment to the Tax Court.
Tax Court judges are not eligible to participate in the
Thrift Savings Plan.
Tax Court judges are subject to limitations on outside
earned income under the Ethics in Government Act of 1978.
REASONS FOR CHANGE
Tax Court judges receive compensation at the same rate as
U.S. District Court judges. In addition, the benefit programs
for Tax Court judges are intended to accord with similar
programsapplicable to U.S. District Court judges.\183\ However,
subsequent legislative changes in the benefits provided to U.S.
District Court judges have not applied to Tax Court judges, thus
creating disparities between the treatment of Tax Court judges and the
treatment of U.S. District Court judges. The Committee believes that
parity should exist between the benefits provided to Tax Court judges
and those provided to U.S. District Court judges.
---------------------------------------------------------------------------
\183\ See, e.g., S. Rep. No. 91-552, at 303 (1969).
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EXPLANATION OF PROVISION
Survivor annuities for assassinated judges
Under the provision, benefits under the survivors' annuity
plan are payable if a Tax Court judge is assassinated before
the judge has performed five years of service.
Cost-of-living adjustments for survivor annuities
The provision provides that cost-of-living increases in
benefits under the survivors' annuity plan are generally based
on cost-of-living increases in benefits paid under the Civil
Service Retirement System.
Life insurance coverage
Under the provision, a judge or retired judge of the Tax
Court is deemed to be an employee continuing in active
employment for purposes of participation in the Federal
Employees Group Life Insurance program. In addition, in the
case of a Tax Court judge age 65 or over, the Tax Court is
authorized to pay on behalf of the judge any increase in
employee premiums under the FEGLI program that occur after
April 24, 1999,\184\ including expenses generated by such
payment, as authorized by the chief judge of the Tax Court in a
manner consistent with payments authorized by the Judicial
Conference of the United States (i.e., the body with policy-
making authority over the administration of the courts of the
Federal judicial branch).
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\184\ This date relates to changes in the FEGLI program, including
changes to premium rates to reflect employees' ages.
---------------------------------------------------------------------------
Accrued annual leave
Under the provision, in the case of a judge who is employed
by the Federal executive branch before appointment to the Tax
Court, the judge is entitled to receive a lump-sum payment for
the balance of his or her accrued annual leave on appointment
to the Tax Court.
Thrift Savings Plan participation
Under the provision, Tax Court judges are permitted to
participate in the Thrift Savings Plan. A Tax Court judge is
not eligible for agency contributions to the Thrift Savings
Plan.
Exemption for teaching compensation from outside earned income
limitations
Under the provision, compensation earned by a retired Tax
Court judge for teaching is not treated as outside earned
income for purposes of limitations under the Ethics in
Government Act of 1978.
EFFECTIVE DATE
The provisions are effective on the date of enactment,
except that: (1) the provision relating to cost-of-living
increases in benefits under the survivors' annuity plan applies
with respect to increases in Civil Service Retirement benefits
taking effect after the date of enactment; (2) the provision
relating to payment of accrued annual leave applies to any Tax
Court judge with an outstanding leave balance as of the date of
enactment and to any individual appointed to serve as a Tax
Court judge after such date; (3) the provision relating to
participation by Tax Court judges in the Thrift Savings Plan
applies as of the next open season; and (4) the provision
relating to teaching compensation of a retired Tax Court judge
applies to any individual serving as a retired Tax Court judge
on or after the date of enactment.
B. Special Trial Judges of the Tax Court
(Secs. 708-713 of the bill, and sec. 7448 and new Secs. 7443A, 7443B,
and 7443C of the Code)
PRESENT LAW
The Tax Court is established by the Congress pursuant to
Article I of the U.S. Constitution.\185\ The chief judge of the
Tax Court may appoint special trial judges to handle certain
cases.\186\ Special trial judges serve for an indefinite term.
Special trial judges receive a salary of 90 percent of the
salary of a Tax Court judge and are generally covered by the
benefit programs that apply to Federal executive branch
employees, including the Civil Service Retirement System or the
Federal Employees' Retirement System.
---------------------------------------------------------------------------
\185\ Sec. 7441.
\186\ Sec. 7443A.
---------------------------------------------------------------------------
REASONS FOR CHANGE
Special trial judges of the Tax Court perform a role
similar to that of magistrate judges in courts established
under Article III of the U.S. Constitution (``Article III''
courts). However, disparities exist between the positions of
magistrate judges of Article III courts and special trial
judges of the Tax Court. For example, magistrate judges of
Article III courts are appointed for a specific term, are
subject to removal only in limited circumstances, and are
eligible for coverage under special retirement and survivor
benefit programs. The Committee believes that special trial
judges of the Tax Court and magistrate judges of Article III
courts should receive comparable treatment as to the status of
the position, salary, and benefits.
EXPLANATION OF PROVISION
Magistrate judges of the Tax Court
Under the provision, the position of special trial judge of
the Tax Court is renamed as magistrate judge of the Tax Court.
Magistrate judges are appointed (or reappointed) to serve for
eight-year terms and are subject to removal in limited
circumstances.
Under the provision, a magistrate judge receives a salary
of 92 percent of the salary of a Tax Court judge.
The provision exempts magistrate judges from the leave
program that applies to employees of the Federal executive
branch and provides rules for individuals who are subject to
such leave program before becoming exempt.
Survivors' annuity plan
Under the provision, magistrate judges of the Tax Court may
elect to participate in the survivors' annuity plan for Tax
Court judges. An election to participate in the survivors'
annuity plan must be filed not later than the latest of six
months after: (1) the date of enactment of the provision; (2)
the date the judge takes office; or (3) the date the judge
marries.
Retirement annuity program for magistrate judges
The provision establishes a new retirement annuity program
for magistrate judges of the Tax Court, under which a
magistrate judge may elect to receive a retirement annuity from
the Tax Court in lieu of benefits under another Federal
retirement program. A magistrate judge may elect to be covered
by the retirement program within five years of appointment or
five years of date of enactment. A magistrate judge who elects
to be covered by the retirement program generally receives a
refund of contributions (with interest) made to the Civil
Service Retirement System or the Federal Employees' Retirement
System.
A magistrate judge may retire at age 65 with 14 years of
service and receive an annuity equal to his or her salary at
the time of retirement. For this purpose, service may include
service performed as a special trial judge or a magistrate
judge, provided the service is performed no earlier than 9\1/2\
years before the date of enactment of the provision. The
provision also provides for payment of a reduced annuity in the
case a magistrate judge with at least eight years of service or
in the case of disability or failure to be reappointed.
A magistrate judge receiving a retirement annuity is
entitled to cost-of-living increases based on cost-of-living
increases in benefits paid under the Civil Service Retirement
System. However, such an increase cannot cause the retirement
annuity to exceed the current salary of a magistrate judge.
Contributions of one percent of salary are withheld from
the salary of a magistrate judge who elects to participate in
the retirement annuity program. Such contributions must be made
also with respect to prior service for which the magistrate
judge elects credit under the retirement annuity program. No
contributions are required after 14 years of service. A lump
sum refund of the magistrate judge's contributions (with
interest) is made if no annuity is payable, for example, if the
magistrate judge dies before retirement.
A magistrate judge's right to a retirement annuity is
generally suspended or reduced in the case of employment
outside the Tax Court.
The provision includes rules under which annuity payments
may be made to a person other than the magistrate judge in
certain circumstances, such as divorce or legal separation,
under a court decree, a court order, or court-approved property
settlement.
The provision establishes the Tax Court Judicial Officers'
Retirement Fund (the ``Fund''). Amounts in the Fund are
authorized to be appropriated for the payment of annuities,
refunds, and other payments under the retirement annuity
program. Contributions withheld from a magistrate judge's
salary are deposited in the Fund. In addition, the provision
authorizes to be appropriated to the Fund amounts required to
reduce the Fund's unfunded liability to zero. For this purpose,
the Fund's unfunded liability means the estimated excess,
actuarially determined on an annual basis, of the present value
of benefits payable from the Fund over the sum of (1) the
present value of contributions to be withheld from the future
salary of the magistrate judges and (2) the balance in the Fund
as of the date the unfunded liability is determined.
Under the provision, a magistrate judge who elects to
participate in the retirement annuity program is also permitted
to participate in the Thrift Savings Plan. Such a magistrate
judge is not eligible for agency contributions to the Thrift
Savings Plan.
Retirement annuity rule for incumbent magistrate judges
The provision provides a transition rule for magistrate
judges in active service on the date of enactment of the
provision. Under the transition rule, such a magistrate judge
is entitled to an annuity under the Civil Service Retirement
System or the Federal Employees' Retirement System based on
prior service that is not credited under the magistrate judges'
retirement annuity program. If the magistrate judge made
contributions to the Civil Service Retirement System or the
Federal Employees' Retirement System with respect to service
that is credited under the magistrate judges' retirement
annuity program, such contributions are refunded (with
interest).
A magistrate judge who elects the transition rule is also
entitled to the annuity payable under the magistrate judges'
retirement program in the case of retirement with at least
eight years of service or on failure to be reappointed. This
annuity is based on service as a magistrate judge or special
trial judge of the Tax Court that is performed no earlier than
9\1/2\ years before the date of enactment of the provision and
for which the magistrate judge makes contributions of one
percent of salary.
Recall of retired magistrate judges
The provision provides rules under which a retired
magistrate judge may be recalled to perform services for a
limited period.
EFFECTIVE DATE
The provisions are effective on date of enactment.
TITLE VIII. OTHER PROVISIONS
A. Temporary Exclusion for Education Benefits Provided by Employers to
Children of Employees
(Sec. 801 of the bill and sec. 127 of the Code)
PRESENT LAW
Up to $5,250 annually of employer-paid educational expenses
are excludable from the gross income and wages of an employee
if provided under a section 127 educational assistance
plan.\187\ The exclusion does not apply with respect to
education provided to an individual other than the employee,
e.g., a child of the employee.
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\187\ Employer-paid educational expenses of the employee that do
not qualify for the section 127 exclusion may be excludable from gross
income if the education (1) maintains or improves a skill required in a
trade or business currently engaged in by the taxpayer, or (2) meets
the express requirements of the taxpayer's employer, applicable law or
regulations imposed as a condition of continued employment.
---------------------------------------------------------------------------
In order for the exclusion to apply, certain requirements
must be satisfied. The educational assistance must be provided
pursuant to a separate written plan of the employer. The
educational assistance program must not discriminate in favor
of highly compensated employees. In addition, not more than
five percent of the amounts paid or incurred by the employer
during the year for educational assistance under a qualified
educational assistance plan can be provided for the class of
individuals consisting of more than five-percent owners of the
employer (and their spouses and dependents).
REASONS FOR CHANGE
The Committee believes that education is key to enabling
Americans to remain competitive in the workforce and that
employers should be encouraged to pay for the educational
expenses of children of employees.
EXPLANATION OF PROVISION
The provision provides that post-secondary educational
benefits provided to children of employees are excludable from
the gross income of the employee under section 127. The maximum
amount excludable for a taxable year with respect to a child of
an employee may not exceed $1,000. In addition, the aggregate
annual amount excludable from an employee's income for a year
with respect to education of the employee and education of the
employee's children cannot exceed $5,250. The exclusion does
not apply for employment tax purposes. The exclusion expires
with respect to years beginning after December 31, 2005.
EFFECTIVE DATE
The provision is effective for taxable years beginning
after December 31, 2004, and before January 1, 2006.
B. Exclusion From Gross Income for Amounts Paid Under National Health
Service Corps Loan Repayment Program
(Sec. 802 of the bill and sec. 108 of the Code)
PRESENT LAW
The National Health Service Corps Loan Repayment Program
(the ``NHSC Loan Repayment Program'') provides education loan
repayments to participants on condition that the participants
provide certain services. In the case of the NHSC Loan
Repayment Program, the recipient of the loan repayment is
obligated to provide medical services in a geographic area
identified by the Public Health Service as having a shortage of
health-care professionals. Loan repayments may be as much as
$35,000 per year of service plus a tax assistance payment of 39
percent of the repayment amount.
States may also provide for education loan repayment
programs for persons who agree to provide primary health
services in health professional shortage areas. Under the
Public Health Service Act, such programs may receive Federal
grants with respect to such repayment programs if certain
requirements are satisfied.
Generally, gross income means all income from whatever
source derived including income for the discharge of
indebtedness. However, gross income does not include discharge
of indebtedness income if: (1) the discharge occurs in a Title
11 case; (2) the discharge occurs when the taxpayer is
insolvent; (3) the indebtedness discharged is qualified farm
indebtedness; or (4) except in the case of a C corporation, the
indebtedness discharged is qualified real property business
indebtedness.
Because the loan repayments provided under the NHSC Loan
Repayment Program or similar State programs under the Public
Health Service Act are not specifically excluded from gross
income, they are gross income to the recipient. There is also
no exception from employment taxes (FICA and FUTA) for such
loan repayments.
REASONS FOR CHANGE
The Committee believes that elimination of the tax on loan
repayments provided under the NHSC Loan Repayment Program and
similar State programs will free up NHSC resources which are
currently being used to pay for services that will be provided
by medical professionals as a condition of loan repayment and
improve the ability of the NHSC to attract medical
professionals to underserved areas.
EXPLANATION OF PROVISION
The provision excludes from gross income and employment
taxes education loan repayments provided under the NHSC Loan
Repayment Program and State programs eligible for funds under
the Public Health Service Act.
EFFECTIVE DATE
The provision is effective with respect to amounts received
in taxable years beginning after December 31, 2004.
C. Temporary Exclusion for Group Legal Services Benefits
(Sec. 803 of the bill and secs. 120 and 501(c)(20) of the Code)
PRESENT LAW
For taxable years beginning before July 1, 1992, certain
amounts contributed by an employer to a qualified group legal
services plan for an employee (or the employee's spouse or
dependents) or the value of legal services provided (or amounts
paid for legal services) under such a plan with respect to an
employee (or the employee's spouse or dependents) are
excludable from an employee's gross income for income and
employment tax purposes.\188\ The exclusion is limited to an
annual premium value of $70.
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\188\ Sec. 120.
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Additionally, for taxable years beginning before July 1,
1992, an organization the exclusive function of which is to
provide legal services or indemnification against the cost of
legal services as part of a qualified group legal services plan
is exempt from tax.\189\
---------------------------------------------------------------------------
\189\ Sec. 501(c)(20).
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REASONS FOR CHANGE
The Committee believes that it is appropriate to
temporarily restore the exclusion for employer-provided group
legal services without limiting the amount of the exclusion and
to temporarily provide tax-exempt status for organizations
which provide qualified group legal services.
EXPLANATION OF PROVISION
The provision restores the exclusion for employer-provided
group legal services for taxable years beginning after December
31, 2004, and before January 1, 2006. The amount of the
exclusion is not limited. Additionally, for taxable years
beginning after December 31, 2004, and before January 1, 2006,
the provision provides tax-exempt status for organizations
which provide qualified group legal services.
EFFECTIVE DATE
The provision applies to taxable years beginning after
December 31, 2004, and before January 1, 2006.
D. Transfer of Funds From Black Lung Trust Fund to Combined Benefit
Fund
(Sec. 804 of the bill and secs. 501(c)(21) and 9705 of the Code)
PRESENT LAW
Qualified black lung benefit trusts
A qualified black lung benefit trust is exempt from Federal
income taxation. Contributions to a qualified black lung
benefit trust generally are deductible to the extent such
contributions are necessary to fund the trust.
Under present law, no assets of a qualified black lung
benefit trust may be used for, or diverted to, any purpose
other than (1) to satisfy liabilities, or pay insurance
premiums to cover liabilities, arising under the Black Lung
Acts, (2) to pay administrative costs of operating the trust,
(3) to pay accident and health benefits or premiums for
insurance exclusively covering such benefits (including
administrative and other incidental expenses relating to such
benefits) for retired coal miners and their spouses and
dependents (within certain limits) or (4) investment in
Federal, State, or local securities and obligations, or in time
demand deposits in a bank or insured credit union.
Additionally, trust assets may be paid into the national Black
Lung Disability Trust Fund, or into the general fund of the
U.S. Treasury.
The amount of assets in qualified black lung benefit trusts
available to pay accident and health benefits or premiums for
insurance exclusively covering such benefits (including
administrative and other incidental expenses relating to such
benefits) for retired coal miners and their spouses and
dependents may not exceed a yearly limit or an aggregate limit,
whichever is less. The yearly limit is the amount of trust
assets in excess of 110 percent of the present value of the
liability for black lung benefits determined as of the close of
the preceding taxable year of the trust. The aggregate limit is
the excess of the sum of the yearly limit as of the close of
the last taxable year ending before October 24, 1992, plus
earnings thereon as of the close of the taxable year preceding
the taxable year involved over the aggregate payments for
accident of health benefits for retired coal miners and their
spouses and dependents made from the trust since October 24,
1992. Each of these determinations is required to be made by an
independent actuary.
In general, amounts used to pay retiree accident or health
benefits are not includible in the income of the company, nor
is a deduction allowed for such amounts.
United Mine Workers of America Combined Benefit Fund
The United Mine Workers of America (``UMWA'') Combined
Benefit Fund was established by the Coal Industry Retiree
Health Benefit Act of 1992 to assume responsibility of payments
for medical care expenses of retired miners and their
dependents who were eligible for heath care from the private
1950 and 1974 UMWA Benefit Plans. The UMWA Combined Benefit
Fund is financed by assessments on current and former
signatories to labor agreements with the UMWA, past transfers
from an overfunded United Mine Workers pension fund, and
transfers from the Abandoned Mine Reclamation Fund.
REASONS FOR CHANGE
The Committee believes that better than expected market
performance of black lung trust assets and fewer black lung
claims have resulted in a situation where some coal companies
have significant unanticipated excess assets in their black
lung trusts. Removing the aggregate limit on the amount of
black lung benefit trusts available to pay accident and health
benefits or premiums for insurance exclusively covering such
benefits for retired coal miners will allow coal companies to
use greater amounts of their excess black lung trust assets to
fund such benefits. Depositing the revenue raised by
eliminating the aggregate limit into the UMWA Combined Benefit
Fund will help to fund retired coal miners' health benefits.
EXPLANATION OF PROVISION
The provision eliminates the aggregate limit on the amount
of excess black lung benefit trust assets that may be used to
pay accident and health benefits or premiums for insurance
exclusively covering such benefits (including administrative
and other incidental expenses relating to such benefits) for
retired coal miners and their spouses and dependents. In
addition, under the provision, each fiscal year, the Secretary
of the Treasury will transfer to the UMWA Combined Benefit Fund
an amount which the Secretary estimates to be the additional
amounts received in the Treasury for that fiscal year by reason
of the elimination of the aggregate limit. The Secretary will
adjust the amount transferred for any year to the extent
necessary to correct errors in any estimate for any prior year.
Any amount transferred to the UMWA Combined Benefit Fund under
the provision will be used to proportionately reduce the
unassigned beneficiary premium of each assigned operator for
the plan year in which transferred.
EFFECTIVE DATE
The provision is effective for taxable years beginning
after December 31, 2002.
E. Extension of Provision Permitting Qualified Transfers of Excess
Pension Assets to Retiree Health Accounts
(Sec. 420 of the Code, and secs. 101, 403 and 408 of ERISA)
PRESENT LAW\190\
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\190\ Present law refers to the law in effect on the dates of
Committee action on the bill. It does not reflect the changes made by
the Pension Equity Funding Act of 2004, Pub. L. No. 108-218 (April 10,
2004).
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Defined benefit plan assets generally may not revert to an
employer prior to termination of the plan and satisfaction of
all plan liabilities. In addition, a reversion may occur only
if the plan so provides. A reversion prior to plan termination
may constitute a prohibited transaction and may result in plan
disqualification. Any assets that revert to the employer upon
plan termination are includible in the gross income of the
employer and subject to an excise tax. The excise tax rate is
20 percent if the employer maintains a replacement plan or
makes certain benefit increases in connection with the
termination; if not, the excise tax rate is 50 percent. Upon
plan termination, the accrued benefits of all plan participants
are required to be 100-percent vested.
A pension plan may provide medical benefits to retired
employees through a separate account that is part of such plan.
A qualified transfer of excess assets of a defined benefit plan
to such a separate account within the plan may be made in order
to fund retiree health benefits.\191\ A qualified transfer does
not result in plan disqualification, is not a prohibited
transaction, and is not treated as a reversion. Thus,
transferred assets are not includible in the gross income of
the employer and are not subject to the excise tax on
reversions. No more than one qualified transfer may be made in
any taxable year. A qualified transfer may not be made from a
multiemployer plan.
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\191\ Sec. 420.
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Excess assets generally means the excess, if any, of the
value of the plan's assets\192\ over the greater of (1) the
accrued liability under the plan (including normal cost) or (2)
125 percent of the plan's current liability.\193\ In addition,
excess assets transferred in a qualified transfer may not
exceed the amount reasonably estimated to be the amount that
the employer will pay out of such account during the taxable
year of the transfer for qualified current retiree health
liabilities. No deduction is allowed to the employer for (1) a
qualified transfer or (2) the payment of qualified current
retiree health liabilities out of transferred funds (and any
income thereon).
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\192\ The value of plan assets for this purpose is the lesser of
fair market value or actuarial value.
\193\ In the case of plan years beginning before January 1, 2004,
excess assets generally means the excess, if any, of the value of the
plan's assets over the greater of (1) the lesser of (a) the accrued
liability under the plan (including normal cost) or (b) 170 percent of
the plan's current liability (for 2003), or (2) 125 percent of the
plan's current liability. The current liability full funding limit was
repealed for years beginning after 2003. Under the general sunset
provision of EGTRRA, the limit is reinstated for years after 2010.
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Transferred assets (and any income thereon) must be used to
pay qualified current retiree health liabilities for the
taxable year of the transfer. Transferred amounts generally
must benefit pension plan participants, other than key
employees, who are entitled upon retirement to receive retiree
medical benefits through the separate account. Retiree health
benefits of key employees may not be paid out of transferred
assets.
Amounts not used to pay qualified current retiree health
liabilities for the taxable year of the transfer are to be
returned to the general assets of the plan. These amounts are
not includible in the gross income of the employer, but are
treated as an employer reversion and are subject to a 20-
percent excise tax.
In order for the transfer to be qualified, accrued
retirement benefits under the pension plan generally must be
100-percent vested as if the plan terminated immediately before
the transfer (or in the case of a participant who separated in
the one-year period ending on the date of the transfer,
immediately before the separation).
In order to a transfer to be qualified, the employer
generally must maintain retiree health benefits at the same
level for the taxable year of the transfer and the following
four years.
In addition, the Employee Retirement Income Security Act of
1974 (``ERISA'') provides that, at least 60 days before the
date of a qualified transfer, the employer must notify the
Secretary of Labor, the Secretary of the Treasury, employee
representatives, and the plan administrator of the transfer,
and the plan administrator must notify each plan participant
and beneficiary of the transfer.\194\
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\194\ ERISA sec. 101(e). ERISA also provides that a qualified
transfer is not a prohibited transaction under ERISA or a prohibited
reversion.
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No qualified transfer may be made after December 31, 2005.
REASONS FOR CHANGE
The Committee believes it is appropriate to extend the
ability of employers to transfer assets set aside for pension
benefits to a section 401(h) account for retiree health
benefits as long as the security of employees' pension benefits
is not thereby threatened.
EXPLANATION OF PROVISION
[The bill does not include the provision relating to
qualified transfers of excess defined benefit assets as
approved by the Committee because an identical provision was
enacted into law in the Pension Funding Equity Act of 2004
(Pub. L. No. 108-218) subsequent to Committee action on the
bill. The following discussion describes the Committee action.]
The provision approved by the Committee would have allowed
qualified transfers of excess defined benefit plan assets
through December 31, 2013.\195\
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\195\ A separate provision of the bill allows qualified transfers
for a certain multiemployer plan.
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EFFECTIVE DATE
The provision approved by the Committee would have been
effective on the date of enactment.
F. Application of Basis Rules to Nonresident Aliens
(Sec. 811 of the bill and new sec. 72(w) of the Code)
PRESENT LAW
Distributions from retirement plans
Distributions from retirement plans are includible in gross
income under the rules relating to annuities\196\ and, thus,
are generally includible in income, except to the extent the
amount received represents investment in the contract (i.e.,
the participant's basis). The participant's basis includes
amounts contributed by the participant on an after-tax basis,
together with certain amounts contributed by the employer,
minus the aggregate amount (if any) previously distributed to
the extent that such amount was excludable from gross income.
Amounts contributed by the employer are included in the
calculation of the participant's basis only to the extent that
such amounts were includible in the gross income of the
participant, or to the extent that such amounts would have been
excludable from the participant's gross income if they had been
paid directly to the participant at the time they were
contributed.\197\
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\196\ Secs. 72 and 402.
\197\ Sec. 72(f).
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Employer contributions to retirement plans and other
payments for labor or personal services performed outside the
United States by a nonresident alien generally are not treated
as U.S. source income. Such contributions, therefore, generally
would not be includible in the nonresident alien's gross income
if they had been paid directly to the nonresident alien at the
time they were contributed. Consequently, the amounts of such
contributions generally are includible in the employee's basis
and are not taxed by the United States if a distribution is
made when the employee is a U.S. citizen or resident.\198\
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\198\ Rev. Rul. 58-236, 1958-1 C.B. 37.
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Earnings on contributions are not included in basis unless
previously includible in income. In general, in the case of a
nonexempt trust, earnings are includible in income when
distributed or made available.\199\ In the case of highly
compensated employees, the amount of the vested accrued benefit
under the trust (other than the employee's investment in the
contract) is generally required to be included in income
annually (i.e., earnings are taxed as they accrue).\200\
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\199\ Sec. 402(b)(2).
\200\ Sec. 402(b)(4).
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U.S. income tax treaties
Under the 1996 U.S. Model Income Tax Treaty (``U.S.
Model'') and some U.S. income tax treaties in force, retirement
plan distributions beneficially owned by a resident of a treaty
country in consideration for past employment generally are
taxable only by the individual recipient's country of
residence. Under the U.S. Model treaty and some U.S. income tax
treaties, this exclusive residence-based taxation rule is
limited to the taxation of amounts that were not previously
included in taxable income in the other country. For example,
if a treaty country had imposed tax on a resident individual
with respect to some portion of a retirement plan's earnings,
subsequent distributions to that person while a resident of the
United States would not be taxable in the United States to the
extent the distributions were attributable to such previously
taxed amounts.
Compensation of employees of foreign governments or international
organizations
Under section 893, wages, fees, and salaries of any
employee of a foreign government or international organization
(including a consular or other officer or a nondiplomatic
representative) received as compensation for official services
to the foreign government or international organization
generally are excluded from gross income when (1) the employee
is not a citizen of the United States, or is a citizen of the
Republic of the Philippines (whether or not a citizen of the
United States); (2) in the case of an employee of a foreign
government, the services are of a character similar to those
performed by employees of the United States in foreign
countries; and (3) in the case of an employee of a foreign
government, the foreign government grants an equivalent
exemption to employees of the United States performing similar
services in such foreign country. The Secretary of State
certifies the names of the foreign countries which grant an
equivalent exclusion to employees of the United States
performing services in those countries, and the character of
those services.
The exclusion does not apply to employees of controlled
commercial entities or employees of foreign governments whose
services are primarily in connection with commercial activity
(whether within or outside the United States) of the foreign
government.
REASONS FOR CHANGE
The Committee believes the present-law rules governing the
calculation of basis provide an inflated basis in assets in
retirement and similar arrangements for many individuals who
become U.S. residents after accruing benefits under such
arrangements. The Committee believes the ability of former
nonresident aliens to receive tax-free distributions from such
arrangements of amounts which have not been previously taxed is
inconsistent with the taxation of benefits paid to individuals
who both accrue and receive distributions of benefits from such
arrangements as U.S. residents (i.e., basis generally includes
only previously-taxed amounts). The Committee believes that the
present-law statutory rule which allows basis in contributions
to such arrangements for individuals who become U.S. residents
after they accrue benefits is inappropriate. While there is no
comparable statutory provision providing basis for earnings,
the Committee is aware that some taxpayers take the position
that there is basis in the earnings on such contributions, even
though such amounts have not been subject to tax. The Committee
believes it is appropriate to provide more equitable taxation
with respect to the distributions of both contributions and
earnings from such arrangements.
EXPLANATION OF PROVISION
The provision modifies the present-law rules under which
certain contributions and earnings that have not been
previously taxed are treated as basis. Under the provision,
employee or employer contributions are not included in basis
if: (1) the employee was a nonresident alien at the time the
services were performed with respect to which the contribution
was made; (2) the contribution is with respect to compensation
for labor or personal services from sources without the United
States; and (3) the contribution was not subject to income tax
under the laws of the United States or any foreign country.
Similarly, under the provision, earnings on employer or
employee contributions are not included in basis if: (1) the
earnings are paid or accrued with respect to any employer or
employee contributions which were made with respect to
compensation for labor or personal services; (2) the employee
was a nonresident alien at the time the earnings were paid or
accrued; and (3) the earnings were not subject to income tax
under the laws of the United States or any foreign country. No
inference is intended that under present law there is basis for
earning not previously subject to tax.
The provision does not change the rules applicable to
calculation of basis with respect to contributions or earnings
while an employee is a U.S. resident. For example, suppose
employer contributions were made to a retirement plan on behalf
of an individual (E) while the individual was a nonresident
alien. The contributions were not subject to income tax in the
United States or a foreign country. Suppose the contributions
are in a discriminatory nonexempt trust so that earnings on the
trust would be taxable to E if E were a United States resident;
however, because E is a nonresident alien, E is not subject to
tax on the earnings. Suppose E then relocates to the United
States and becomes a U.S. resident, during which time earnings
on the trust are taxable under the rules requiring income
inclusion of vested accrued amounts for highly compensated
employees. E's basis does not include the employer
contributions, nor any earnings paid or accrued while E was a
nonresident alien. E's basis will include the earnings
includible in gross income while E was a U.S. resident.
There is no inference that this provision applies in any
case to create tax jurisdiction with respect to wages, fees,
and salaries otherwise exempt under section 893. Similarly,
there is no inference that this provision applies where
contrary to an agreement of the United States that has been
validly authorized by Congress (or in the case of a treaty,
ratified by the Senate), and which provides an exemption for
income.
Most U.S. tax treaties specifically address the taxation of
pension distributions. The U.S. Model treaty provides for
exclusive residence-based taxation of pension distributions to
the extent such distributions were not previously included in
taxable income in the other country. For treaty purposes, the
United States treats any amount that has increased the
recipient's basis (as defined in section 72) as having been
previously included in taxable income. The following example
illustrates how the provision could affect the amount of a
distribution that may be taxed by the United States pursuant to
a tax treaty.
Assume the following facts. A, a nonresident alien
individual, performs services outside the United States. A's
employer makes contributions on behalf of A to a pension plan
established in A's country of residence, Z. For U.S. tax
purposes, no portion of the contributions or earnings are
included in A's gross income because such amounts relate to
services performed without the United States.\201\ Later in
time, A retires and becomes a resident alien of the United
States.
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\201\ Sec. 872.
---------------------------------------------------------------------------
Under the provision, the employer contributions to the
pension plan would not be taken into account in determining A's
basis unless A was subject to income tax on the contributions
by a foreign country. If A was not subject to tax on such
amounts by a foreign country, A would be subject to U.S. tax on
the entire amount of contributions. Earnings that accrued while
A was a nonresident alien would be subject to the provision.
Earnings that accrued while A was a resident of the United
States would be subject to present-law rules. This result is
consistent with the treatment of pension distributions under
the U.S. Model treaty, which provides for residence-based
taxation only to the extent such amounts have not been taxed
previously by the treaty partner.
Even though A is a resident alien under U.S. statutory
rules, if A is a resident of country Y, with which the United
States has an income tax treaty (including a pension provision
identical to the U.S. Model) and A qualifies for benefits as a
resident of Y under the U.S.-Y treaty, A would be subject to
U.S. tax on the distributions only to the extent the amounts
were not previously included in A's taxable income in country
Y. Thus, if Y had taxed A on the employer contributions or the
earnings of the plan, distributions attributable to these
previously taxed amounts would not be subject to U.S. income
tax pursuant to the U.S.-Y tax treaty. On the other hand, if Z
rather than Y had taxed A on the employer contributions or
earnings of the plan, the pension provision in the U.S.-Y
treaty would not apply.
The provision authorizes the Secretary of the Treasury to
issue regulations to carry out the purposes of this provision,
including regulations treating contributions as not subject to
income tax under the laws of any foreign country under
appropriate circumstances. For example, Treasury could provide
that foreign income tax that was merely nominal would not
satisfy the ``subject to income tax'' requirement.
EFFECTIVE DATE
The provision is effective for distributions occurring on
or after the date of enactment. No inference is intended that
the earnings subject to the provision are included in basis
under present law.
G. Modify Qualification Rules for Tax-Exempt Property and Casualty
Insurance Companies and Modify Definition of Insurance Company for
Property and Casualty Insurance Company
(Secs. 501(c)(15) and 831(b) and (c) of the Code)
PRESENT LAW \202\
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\202\ Present law refers to the law in effect on the dates of
Committee action on the bill. It does not reflect the changes made by
the Pension Funding Equity Act of 2004, Pub. L. No. 108-218 (April 10,
2004).
---------------------------------------------------------------------------
Qualification rules
A property and casualty insurance company generally is
subject to tax on its taxable income (sec. 831(a)). The taxable
income of a property and casualty insurance company is
determined as the sum of its underwriting income and investment
income (as well as gains and other income items), reduced by
allowable deductions (sec. 832).
A property and casualty insurance company is eligible to be
exempt from Federal income tax if its net written premiums or
direct written premiums (whichever is greater) for the taxable
year do not exceed $350,000 (sec. 501(c)(15)).
A property and casualty insurance company may elect to be
taxed only on taxable investment income if its net written
premiums or direct written premiums (whichever is greater) for
the taxable year exceed $350,000, but do not exceed $1.2
million (sec. 831(b)).
For purposes of determining the amount of a company's net
written premiums or direct written premiums under these rules,
premiums received by all members of a controlled group of
corporations of which the company is a part are taken into
account. For this purpose, a more-than-50-percent threshhold
applies under the vote and value requirements with respect to
stock ownership for determining a controlled group, and rules
treating a life insurance company as part of a separate
controlled group or as an excluded member of a group do not
apply (secs. 501(c)(15), 831(b)(2)(B) and 1563).
Definition of insurance company
Present law provides specific rules for taxation of the
life insurance company taxable income of a life insurance
company (sec. 801), and for taxation of the taxable income of
an insurance company other than a life insurance company (sec.
831) (generally referred to as a property and casualty
insurance company). For Federal income tax purposes, a life
insurance company means an insurance company that is engaged in
the business of issuing life insurance and annuity contracts,
or noncancellable health and accident insurance contracts, and
that meets a 50-percent test with respect to its reserves (sec.
816(a)). This statutory provision applicable to life insurance
companies explicitly defines the term ``insurance company'' to
mean any company, more than half of the business of which
during the taxable year is the issuing of insurance or annuity
contracts or the reinsuring of risks underwritten by insurance
companies (sec. 816(a)).
The life insurance company statutory definition of an
insurance company does not explicitly apply to property and
casualty insurance companies, although a long-standing Treasury
regulation \203\ that is applied to property and casualty
companies provides a somewhat similar definition of an
``insurance company'' based on the company's ``primary and
predominant business activity.'' \204\
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\203\ The Treasury regulation provides that ``the term `insurance
company' means a company whose primary and predominant business
activity during the taxable year is the issuing of insurance or annuity
contracts or the reinsuring of risks underwritten by insurance
companies. Thus, though its name, charter powers, and subjection to
State insurance laws are significant in determining the business which
a company is authorized and intends to carry on, it is the character of
the business actually done in the taxable year which determines whether
a company is taxable as an insurance company under the Internal Revenue
Code.'' Treas. Reg. section 1.801-3(a)(1).
\204\ Court cases involving a determination of whether a company is
an insurance company for Federal tax purposes have examined all of the
business and other activities of the company. In considering whether a
company is an insurance company for such purposes, courts have
considered, among other factors, the amount and source of income
received by the company from its different activities. See Bowers v.
Lawyers Mortgage Co., 285 U.S. 182 (1932); United States v. Home Title
Insurance Co., 285 U.S. 191 (1932). See also Inter-American Life
Insurance Co. v. Comm'r, 56 T.C. 497, aff'd per curiam, 469 F.2d 697
(9th Cir. 1972), in which the court concluded that the company was not
an insurance company: ``The * * * financial data clearly indicates that
petitioner's primary and predominant source of income was from its
investments and not from issuing insurance contracts or reinsuring
risks underwritten by insurance companies. During each of the years in
issue, petitioner's investment income far exceeded its premiums and the
amounts of earned premiums were de minimis during those years. It is
equally as clear that petitioner's primary and predominant efforts were
not expended in issuing insurance contracts or in reinsurance. Of the
relatively few policies directly written by petitioner, nearly all were
issued to [family members]. Also, Investment Life, in which [family
members] each owned a substantial stock interest, was the source of
nearly all of the policies reinsured by petitioner. These facts,
coupled with the fact that petitioner did not maintain an active sales
staff soliciting or selling insurance policies * * *, indicate a lack
of concentrated effort on petitioner's behalf toward its chartered
purpose of engaging in the insurance business. * * * For the above
reasons, we hold that during the years in issue, petitioner was not `an
insurance company * * * engaged in the business of issuing life
insurance' and hence, that petitioner was not a life insurance company
within the meaning of section 801.'' 56 T.C. 497, 507-508.
---------------------------------------------------------------------------
When enacting the statutory definition of an insurance
company in 1984, Congress stated, ``[b]y requiring [that] more
than half rather than the `primary and predominant business
activity' be insurance activity, the bill adopts a stricter and
more precise standard for a company to be taxed as a life
insurance company than does the general regulatory definition
of an insurance company applicable for both life and nonlife
insurance companies * * * Whether more than half of the
business activity is related to the issuing of insurance or
annuity contracts will depend on the facts and circumstances
and factors to be considered will include the relative
distribution ofthe number of employees assigned to, the amount
of space allocated to, and the net income derived from, the various
business activities.'' \205\
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\205\ H.R. Rep. 98-432, part 2, at 1402-1403 (1984); S. Prt. No.
98-169, vol. I, at 525-526 (1984); see also H.R. Rep. No. 98-861 at
1043-1044 (1985) (Conference Report).
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REASONS FOR CHANGE
The Committee has become aware of abuses in the area of
tax-exempt insurance companies. Considerable media attention
has focused on the inappropriate use of tax-exempt insurance
companies to shelter investment income.\206\ The Committee
believes that the use of these organizations as vehicles for
sheltering income was never contemplated by Congress. The
proliferation of these organizations as a means to avoid tax on
income, sometimes on large investment portfolios, is
inconsistent with the original narrow scope of the provision,
which has been in the tax law for decades. The Committee
believes it is necessary to limit the availability of tax-
exempt status under the provision so that it cannot be abused
as a tax shelter. To that end, the bill applies a gross
receipts test and requires that premiums received for the
taxable year be greater than 50 percent of gross receipts.
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\206\ See David Cay Johnston, Insurance Loophole Helps Rich, N.Y.
Times, April 1, 2003; David Cay Johnston, Tiny Insurers Face Scrutiny
as Tax Shields, N.Y. Times, April 4, 2003, at C1; Janet Novack, Are You
a Chump?, Forbes, Mar. 5, 2001.
---------------------------------------------------------------------------
The bill correspondingly expands the availability of the
present-law election of a property and casualty insurer to be
taxed only on taxable investment income to companies with
premiums below $350,000. This provision of present law provides
a relatively simple tax calculation for small property and
casualty insurers, and because the election results in the
taxation of investment income, the Committee does not believe
that it is abused to avoid tax on investment income. Thus, the
bill provides that a company whose net written premiums (or if
greater, direct written premiums) do not exceed $1.2 million
(without regard to the $350,000 threshhold of present law) is
eligible for the simplification benefit of this election.
The Committee believes that the law will be made clearer
and more exact and tax administration will be improved by
conforming the definition of an insurance company for purposes
of the property and casualty insurance tax rules to the
existing statutory definition of an insurance company under the
life insurance company tax rules. Further, the Committee
expects that IRS enforcement activities to prevent abuse of the
provision relating to tax-exempt insurance companies will be
simplified and improved by this provision of the bill.
EXPLANATION OF PROVISION
[The bill does not include the provisions relating to
qualification rules for an insurance company to be eligible for
tax-exempt status, to elect to be taxed on taxable investment
income and defining an insurance company for these purposes, as
approved by the Committee, because substantially similar
provisions \207\ were enacted into law in the Pension Funding
Equity Act of 2004 (Pub. L. No. 108-218) subsequent to
Committee action on the bill. The following discussion
describes the Committee action.]
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\207\ Section 206 of PFEA 2004 modifies the requirements for a
property and casualty insurance company to be eligible for tax-exempt
status, providing that the company's gross receipts may not exceed
$600,000 and premiums received for the taxable year are required to be
greater than 50 percent of its gross receipts. Section 206 of PFEA 2004
also provides that a property and casualty company may elect to be
taxed only on taxable investment income if its net written premiums or
direct written premiums (whichever is greater) do not exceed $1.2
million. Section 206 of PFEA 2004 modifies the definition of an
insurance company for purposes of these rules to mean any company, more
than half of the business of which during the taxable year is the
issuing of insurance or annuity contracts or the reinsuring of risks
underwritten by insurance companies. Section 206 of PFEA 2004 provides
an additional special rule (not included in the this bill) that a
mutual property and casualty insurance company is eligible to be exempt
from Federal income tax under the provision if (a) its gross receipts
for the taxable year do not exceed $150,000, and (b) the premiums
received for the taxable year are greater than 35 percent of its gross
receipts, provided certain requirements are met. Section 206 of PFEA
provision generally is effective for taxable years beginning after
December 31, 2003, except that a special transition rule (not included
in this bill) is provided with respect to certain companies. This
transition rule applies in the case of a company that, (1) for its
taxable year that includes April 1, 2004, meets the requirements of
present-law section 501(c)(15)(A) (as in effect for the taxable year
beginning before January 1, 2004), and (2) on April 1, 2004, is in a
receivership, liquidation or similar proceeding under the supervision
of a State court. Under the transition rule, in the case of such a
company, the provision applies to taxable years beginning after the
earlier of (1) the date the proceeding ends, or (2) December 31, 2007.
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Qualification rules
The provision in the bill would have modified the
requirements for a property and casualty insurance company to
be eligible for tax-exempt status, and to elect to be taxed
only on taxable investment income.
The provision would have provided that a property and
casualty insurance company is eligible to be exempt from
Federal income tax if (a) its gross receipts for the taxable
year do not exceed $600,000, and (b) the premiums received for
the taxable year are greater than 50 percent of its gross
receipts. For purposes of determining gross receipts, the gross
receipts of all members of a controlled group of corporations
of which the company is a part are taken into account. The
provision would have expanded the present-law controlled group
rule so that it also takes into account gross receipts of
foreign and tax-exempt corporations.
The provision also would have provided that a property and
casualty insurance company may elect to be taxed only on
taxable investment income if its net written premiums or direct
written premiums (whichever is greater) do not exceed $1.2
million (without regard to whether such premiums exceed
$350,000) (sec. 831(b)). As under present law, for purposes of
determining the amount of a company's net written premiums or
direct written premiums under this rule, premiums received by
all members of a controlled group of corporations (as defined
in section 831(b)) of which the company is a part are taken
into account.
It is intended that regulations or other Treasury guidance
provide for anti-abuse rules so as to prevent improper use of
the provision, including, for example, by attempts to
characterize as premiums any income that is other than premium
income.
Definition of insurance company
The provision would have provided that a company that does
not meet the definition of an insurance company is not eligible
to be exempt from Federal income tax. For this purpose, the
term ``insurance company'' means any company, more than half of
the business of which during the taxable year is the issuing of
insurance or annuity contracts or the reinsuring of risks
underwritten by insurance companies (sec. 816(a) and new sec.
831(c)). A company whose investment activities outweigh its
insurance activities is not considered to be an insurance
company for this purpose.\208\ It is intended that IRS
enforcement activities address the misuse of present-law
section 501(c)(15). The provision would have conformed the
definition of an insurance company for purposes of the rules
taxing property and casualty insurance companies to the rules
taxing life insurance companies, so that the definition is
uniform. The provision would have adopted a stricter and more
precise standard than the ``primary and predominant business
activity'' test contained in Treasury Regulations. It is not
intended that a company whose sole activity is the run-off of
risks under the company's insurance contracts be treated as a
company other than an insurance company, even if the company
has little or no premium income.
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\208\ See, e.g., Inter-American Life Insurance Co. v. Comm'r, 56
T.C. 497, aff'd per curiam, 469 F.2d 697 (9th Cir. 1972).
---------------------------------------------------------------------------
EFFECTIVE DATE
The provisions would have been effective for taxable years
beginning after December 31, 2003.
H. Tax Treatment of Company-Owned Life Insurance (``COLI'')
(Secs. 812 and 813 of the bill and new secs. 101(j) and 6039I of the
Code)
PRESENT LAW
Amounts received under a life insurance contract
Amounts received under a life insurance contract paid by
reason of the death of the insured are not includible in gross
income for Federal tax purposes.\209\ No Federal income tax
generally is imposed on a policyholder with respect to the
earnings under a life insurance contract (inside buildup).\210\
---------------------------------------------------------------------------
\209\ Sec. 101(a).
\210\ This favorable tax treatment is available only if a life
insurance contract meets certain requirements designed to limit the
investment character of the contract (sec. 7702).
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Distributions from a life insurance contract (other than a
modified endowment contract) that are made prior to the death
of the insured generally are includible in income to the extent
that the amounts distributed exceed the taxpayer's investment
in the contract (i.e., basis). Such distributions generally are
treated first as a tax-free recovery of basis, and then as
income.\211\
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\211\ Sec. 72(e). In the case of a modified endowment contract,
however, in general, distributions are treated as income first, loans
are treated as distributions (i.e., income rather than basis recovery
first), and an additional 10-percent tax is imposed on the income
portion of distributions made before age 59\1/2\ and in certain other
circumstances (secs. 72(e) and (v)). A modified endowment contract is a
life insurance contract that does not meet a statutory ``7-pay'' test,
i.e., generally is funded more rapidly than seven annual level premiums
(sec. 7702A).
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Premium and interest deduction limitations \212\
Premiums
Under present law, no deduction is permitted for premiums
paid on any life insurance, annuity or endowment contract, if
the taxpayer is directly or indirectly a beneficiary under the
contract.\213\
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\212\ In addition to the statutory limitations described below,
interest deductions under company-owned life insurance arrangements
have also been limited by recent cases applying general principles of
tax law. See Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254
(1999), aff'd 254 F.3d 1313 (11th Cir. 2001), cert. denied, April 15,
2002; Internal Revenue Service v. CM Holdings, Inc., 254 B.R. 578 (D.
Del. 2000), aff'd, 301 F.3d 96 (3d Cir. 2002); American Electric Power,
Inc. v. U.S., 136 F.Supp. 2d 762 (S. D. Ohio 2001), aff'd, 326 F.3d 737
(6th Cir. 2003), reh. denied, 338 F.3d 534 (6th Cir. 2003), cert.
denied, U.S. No. 03-529 (Jan. 12, 2004); but see Dow Chemical Company
v. U.S., 250 F. Supp.2d 748 (E.D. Mich. 2003), modified, Case No. 00-
10331-BC, E. D. Mich., Aug. 12, 2003.
\213\ Sec. 264(a)(1).
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Interest paid or accrued with respect to the contract
No deduction generally is allowed for interest paid or
accrued on any debt with respect to a life insurance, annuity
or endowment contract covering the life of any individual.\214\
An exception is provided under this provision for insurance of
key persons.
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\214\ Sec. 264(a)(4).
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Interest that is otherwise deductible (e.g., is not
disallowed under other applicable rules or general principles
of tax law) may be deductible under the key person exception,
to the extent that the aggregate amount of the debt does not
exceed $50,000 per insured individual. The deductible interest
may not exceed the amount determined by applying a rate based
on a Moody's Corporate Bond Yield Average-Monthly Average
Corporates. A key person is an individual who is either an
officer or a 20-percent owner of the taxpayer. The number of
individuals that can be treated as key persons may not exceed
the greater of (1) five individuals, or (2) the lesser of five
percent of the total number of officers and employees of the
taxpayer, or 20 individuals.\215\
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\215\ Sec. 264(e)(3).
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Pro rata interest limitation
A pro rata interest deduction disallowance rule also
applies. Under this rule, in the case of a taxpayer other than
a natural person, no deduction is allowed for the portion of
the taxpayer's interest expense that is allocable to unborrowed
policy cash surrender values.\216\ Interest expense is
allocable to unborrowed policy cash values based on the ratio
of (1) the taxpayer's average unborrowed policy cash values of
life insurance, annuity and endowment contracts, to (2) the sum
of the average unborrowed cash values (or average adjusted
bases, for other assets) of all the taxpayer's assets.
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\216\ Sec. 264(f). This applies to any life insurance, annuity or
endowment contract issued after June 8, 1997.
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Under the pro rata interest disallowance rule, an exception
is provided for any contract owned by an entity engaged in a
trade or business, if the contract covers an individual who is
a 20-percent owner of the entity, or an officer, director, or
employee of the trade or business. The exception also applies
to a joint-life contract covering a 20-percent owner and his or
her spouse.
``Single premium'' and ``4-out-of-7'' limitations
Other interest deduction limitation rules also apply with
respect to life insurance, annuity and endowment contracts.
Present law provides that no deduction is allowed for any
amount paid or accrued on debt incurred or continued to
purchase or carry a single premium life insurance, annuity or
endowment contract.\217\ In addition, present law provides that
no deduction is allowed for any amount paid or accrued on debt
incurred or continued to purchase or carry a life insurance,
annuity or endowment contract pursuant to a plan of purchase
that contemplates the systematic direct or indirect borrowing
of part or all of the increases in the cash value of the
contract (either from the insurer or otherwise).\218\ Under
this rule, several exceptions are provided, including an
exception if no part of four of the annual premiums due during
the initial seven-year period is paid by means of such debt
(known as the ``4-out-of-7 rule'').
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\217\ Sec. 264(a)(2).
\218\ Sec. 264(a)(3).
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Definitions of highly compensated employee
Present law defines highly compensated employees and
individuals for various purposes. For purposes of
nondiscrimination rules relating to qualified retirement plans,
an employee, including a self-employed individual, is treated
as highly compensated with respect to a year if the employee
(1) was a five-percent owner of the employer at any time during
the year or the preceding year or (2) either (a) had
compensation for the preceding year in excess of $90,000 (for
2004) or (b) at the election of the employer had compensation
in excess of $90,000 (for 2004) and was in the highest paid 20
percent of employees for such year.\219\ The $90,000 dollar
amount is indexed for inflation.
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\219\ Sec. 414(q). For purposes of determining the top-paid 20
percent of employees, certain employees, such as employees subject to a
collective bargaining agreement, are disregarded.
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For purposes of nondiscrimination rules relating to self-
insured medical reimbursement plans, a highly compensated
individual is an employee who is one of the five highest paid
officers of the employer, a shareholder who owns more than 10
percent of the value of the stock of the employer, or is among
the highest paid 25 percent of all employees.\220\
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\220\ Sec. 105(h)(5). For purposes of determining the top-paid 25
percent of employees, certain employees, such as employees subject to a
collective bargaining agreement, are disregarded.
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REASONS FOR CHANGE
The Committee is aware of companies who have, in the past,
purchased insurance on rank-and-file employees and collect the
proceeds years after the employee terminated employment with
the company. To curtail this practice, when proceeds are
payable more than 12 months after termination of employment,
the bill excludes from income only proceeds on policies
purchased on the lives of directors and highly compensated
individuals, including the highest-paid 35 percent of
employees.
The Committee is also aware of reports that in some cases
the insured employee is not aware that his or her life has been
insured. The Committee believes that it is important for
employers to provide notice to insured employees and to obtain
the consent of employees to be insured, and consequently, the
bill imposes notice and consent requirements in order for the
exceptions to the income inclusion rule to apply.
In order to aid compliance with the provisions and
facilitate IRS enforcement, the bill also imposes recordkeeping
requirements with respect to employer-owned life insurance
contracts issued after the date of enactment.
EXPLANATION OF PROVISION
The provision provides generally that, in the case of an
employer-owned life insurance contract, the amount excluded
from the applicable policyholder's income as a death benefit
cannot exceed the premiums and other amounts paid by such
applicable policyholder for the contract. The excess death
benefit is included in income.
Exceptions to this income inclusion rule are provided. In
the case of an employer-owned life insurance contract with
respect to which the notice and consent requirements of the
provision are met, the income inclusion rule does not apply to
an amount received by reason of the death of an insured
individual who, with respect to the applicable policyholder,
was an employee at any time during the 12-month period before
the insured's death, or who, at the time the contract was
issued, was a director or highly compensated employee or highly
compensated individual. For this purpose, such a person is one
who is either: (1) a highly compensated employee as defined
under the rules relating to qualified retirement plans,
determined without regard to the election regarding the top-
paid 20 percent of employees; or (2) a highly compensated
individual as defined under the rules relating to self-insured
medical reimbursement plans, determined by substituting the
highest-paid 35 percent of employees for the highest-paid 25
percent of employees.\221\
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\221\ As under present law, certain employees are disregarded in
making the determinations regarding the top-paid groups.
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In the case of an employer-owned life insurance contract
with respect to which the notice and consent requirements of
the provision are met, the income inclusion rule does not apply
to an amount received by reason of the death of an insured, to
the extent the amount is (1) paid to a member of the family
\222\ of the insured, to an individual who is the designated
beneficiary of the insured under the contract (other than an
applicable policyholder), to a trust established for the
benefit of any such member of the family or designated
beneficiary, or to the estate of the insured; or (2) used to
purchase an equity (or partnership capital or profits) interest
in the applicable policyholder from such a family member,
beneficiary, trust or estate. It is intended that such amounts
be so paid or used by the due date of the tax return for the
taxable year of the applicable policyholder in which they are
received as a death benefit under the insurance contract, so
that the payment of the amount to such a person or persons, or
the use of the amount to make such a purchase, is known in the
taxable year for which the exception from the income inclusion
rule is claimed.
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\222\ For this purpose, a member of the family is defined in
section 267(c)(4) to include only the individual's brothers and sisters
(whether by the whole or half blood), spouse, ancestors, and lineal
descendants.
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An employer-owned life insurance contract is defined for
purposes of the provision as a life insurance contract which
(1) is owned by a person engaged in a trade or business and
under which such person (or a related person) is directly or
indirectly a beneficiary, and (2) covers the life of an
individual who is an employee with respect to the trade or
business of the applicable policyholder on the date the
contract is issued.
An applicable policyholder means, with respect to an
employer-owned life insurance contract, the person (including
related persons) that owns the contract, if the person is
engaged in a trade or business, and if the person (or a related
person) is directly or indirectly a beneficiary under the
contract.
For purposes of the provision, a related person includes
any person that bears a relationship specified in section
267(b) or 707(b)(1) \223\ or is engaged in trades or businesses
that are under common control (within the meaning of section
52(a) or (b)).
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\223\ The relationships include specified relationships among
family members, shareholders and corporations, corporations that are
members of a controlled group, trust grantors and fiduciaries, tax-
exempt organizations and persons that control such organizations,
commonly controlled S corporations, partnerships and C corporations,
estates and beneficiaries, commonly controlled partnerships, and
partners and partnerships. Detailed rules apply to determine the
specific relationships.
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The notice and consent requirements of the provision are
met if, before the issuance of the contract, (1) the employee
is notified in writing that the applicable policyholder intends
to insure the employee's life, and is notified of the maximum
face amount at issue of the life insurance contract that the
employer might take out on the life of the employee, (2) the
employee provides written consent to being insured under the
contract and that such coverage may continue after the insured
terminates employment, and (3) the employee is informed in
writing that an applicable policyholder will be a beneficiary
of any proceeds payable on the death of the employee.
For purposes of the provision, an employee includes an
officer, a director, and a highly compensated employee; an
insured means, with respect to an employer-owned life insurance
contract, an individual covered by the contract who is a U.S.
citizen or resident. In the case of a contract covering the
joint lives of two individuals, references to an insured
include both of the individuals.
The provision requires annual reporting and recordkeeping
by applicable policyholders that own one or more employer-owned
life insurance contracts. The information to be reported is (1)
the number of employees of the applicable policyholder at the
end of the year, (2) the number of employees insured under
employer-owned life insurance contracts at the end of the year,
(3) the total amount of insurance in force at the end of the
year under such contracts, (4) the name, address, and taxpayer
identification number of the applicable policyholder and the
type of business in which it is engaged, and (5) a statement
that the applicable policyholder has a valid consent (in
accordance with the consent requirements under the provision)
for each insured employee and, if all such consents were not
obtained, the total number of insured employees forwhom such
consent was not obtained. The applicable policyholder is required to
keep records necessary to determine whether the requirements of the
reporting rule and the income inclusion rule of new section 101(j) are
met.
EFFECTIVE DATE
The amendments made by this section generally apply to
contracts issued after the date of enactment, except for
contracts issued after such date pursuant to an exchange
described in section 1035 of the Code. In addition, certain
material increases in the death benefit or other material
changes will generally cause a contract to be treated as a new
contract, with an exception for existing lives under a master
contract. Increases in the death benefit that occur as a result
of the operation of section 7702 of the Code or the terms of
the existing contract, provided that the insurer's consent to
the increase is not required, will not cause a contract to be
treated as a new contract. In addition, certain changes to a
contract will not be considered material changes so as to cause
a contract to be treated as a new contract. These changes
include administrative changes, changes from general to
separate account, or changes as a result of the exercise of an
option or right granted under the contract as originally
issued.
Examples of situations in which death benefit increases
would not cause a contract to be treated as a new contract
include the following:
(1) Section 7702 provides that life insurance contracts
need to either meet the cash value accumulation test of section
7702(b) or the guideline premium requirements of section
7702(c) and the cash value corridor of section 7702(d). Under
the corridor test, the amount of the death benefit may not be
less than the applicable percentage of the cash surrender
value. Contracts may be written to comply with the corridor
requirement by providing for automatic increases in the death
benefit based on the cash surrender value. Death benefit
increases required by the corridor test or the cash value
accumulation test do not require the insurer's consent at the
time of increase and occur in order to keep the contact in
compliance with section 7702.
(2) Death benefits may also increase due to normal
operation of the contract. For example, for some contracts,
policyholder dividends paid under the contract may be applied
to purchase paid-up additions, which increase the death
benefits. The insurer's consent is not required for these death
benefit increases.
(3) For variable contacts and universal life contracts, the
death benefit may increase as a result of market performance or
the contract design. For example, some contracts provide that
the death benefit will equal the cash value plus a specified
amount at risk. With these contracts, the amount of the death
benefit at any time will vary depending on changes in the cash
value of the contract. The insurance company's consent is not
required for these death benefit increases.
I. Reporting of Taxable Mergers and Acquisitions
(Sec. 813 of the bill and new sec. 6043A of the Code)
PRESENT LAW
Under section 6045 and the regulations thereunder, brokers
(defined to include stock transfer agents) are required to make
information returns and to provide corresponding payee
statements as to sales made on behalf of their customers,
subject to the penalty provisions of sections 6721-6724. Under
the regulations issued under section 6045, this requirement
generally does not apply with respect to taxable transactions
other than exchanges for cash (e.g., stock inversion
transactions taxable to shareholders by reason of section
367(a)).
REASONS FOR CHANGE
The Committee believes that administration of the tax laws
would be improved by greater information reporting with respect
to taxable non-cash transactions, and that the Treasury
Secretary's authority to require such enhanced reporting should
be made explicit in the Code.
EXPLANATION OF PROVISION
Under the provision, if gain or loss is recognized in whole
or in part by shareholders of a corporation by reason of a
second corporation's acquisition of the stock or assets of the
first corporation, then the acquiring corporation (or the
acquired corporation, if so prescribed by the Treasury
Secretary) is required to make a return containing:
(1) A description of the transaction;
(2) The name and address of each shareholder of the
acquired corporation that recognizes gain as a result of the
transaction (or would recognize gain, if there was a built-in
gain on the shareholder's shares);
(3) The amount of money and the value of stock or other
consideration paid to each shareholder described above; and
(4) Such other information as the Treasury Secretary may
prescribe.
Alternatively, a stock transfer agent who records transfers
of stock in such transaction may make the return described
above in lieu of the second corporation.
In addition, every person required to make a return
described above is required to furnish to each shareholder (or
the shareholder's nominee \224\) whose name is required to be
set forth in such return a written statement showing:
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\224\ In the case of a nominee, the nominee must furnish the
information to the shareholder in the manner prescribed by the
Secretary of the Treasury.
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(1) The name, address, and phone number of the information
contact of the person required to make such return;
(2) The information required to be shown on that return;
and
(3) Such other information as the Treasury Secretary may
prescribe.
This written statement is required to be furnished to the
shareholder on or before January 31 of the year following the
calendar year during which the transaction occurred.
The present-law penalties for failure to comply with
information reporting requirements are extended to failures to
comply with the requirements set forth under the provision.
EFFECTIVE DATE
The provision is effective for acquisitions after the date
of enactment.
III. BUDGET EFFECTS OF THE BILL
A. Committee Estimates
In compliance with paragraph 11(a) of rule XXVI of the
Standing Rules of the Senate, the following statement is made
concerning the estimated budget effects of the provisions of
the bill as reported.
B. Budget Authority and Tax Expenditures
Budget authority
In compliance with section 308(a)(1) of the Budget Act, the
Committee states that the provisions of section 710 of the bill
involve new or increased budget authority with respect to the
Tax Court Judicial Officers' Retirement Fund.
Tax expenditures
In compliance with section 308(a)(2) of the Budget Act, the
Committee states that the revenue-reducing provisions of the
bill involve increased tax expenditures (see revenue table in
Part III.A., above). The revenue increasing provisions of the
bill generally involve reduced tax expenditures (see revenue
table in Part III.A., above).
C. Consultation With Congressional Budget Office
In accordance with section 403 of the Budget Act, the
Committee advises that the Congressional Budget Office has not
submitted a statement on the bill. The letter from the
Congressional Budget Office has not been received, and
therefore will be provided separately.
IV. VOTES OF THE COMMITTEE
In compliance with paragraph 7(b) of rule XXVI of the
Standing Rules of the Senate, the following statements are made
concerning the votes taken on the Committee's consideration of
the bill.
Motion to report the bill
The bill, as modified and amended, was originally ordered
favorably reported by voice vote, a quorum being present, on
September 17, 2003. After consideration of further
modifications and amendments, the bill, as modified and
amended, was ordered favorably reported by voice vote, a quorum
being present, on February 2, 2004.
Votes on amendments
The Committee accepted an amendment by Senator Bingaman
relating to company-owned life insurance (``COLI'') on
September 17, 2003. The Committee also accepted an amendment by
Senator Santorum relating to transfers from the Black Lung
Disability Trust Fund.
V. REGULATORY IMPACT AND OTHER MATTERS
A. Regulatory Impact
Pursuant to paragraph 11(b) of rule XXVI of the Standing
Rules of the Senate, the Committee makes the following
statement concerning the regulatory impact that might be
incurred in carrying out the provisions of the bill as amended.
Impact on individuals and businesses
The bill includes provisions relating to qualified
retirement plans, including provisions designed to increase
retirement income security by (1) providing employees with
greater opportunity to diversify plan investments in employer
securities, (2) requiring plans to provide additional
information with respect to plan benefits and investments, (3)
clarifying fiduciary requirements under ERISA, and (4)
improving employees' retirement savings opportunities,
portability, and spousal protections. The bill also includes a
variety of provisions intended to reduce administrative burdens
on employers with regard to pension plans, including provisions
relating to required funding contributions, reductions of
Pension Benefit Guaranty Corporation premiums for certain
plans, transfers of excess assets to retiree health accounts,
and other plan administration issues. The bill also includes
directives for a number of studies relating to specific issues
that affect retirement income security. Some of these
provisions may impose additional administrative requirements on
employers that sponsor retirement plans; however, in some cases
the employer may avoid application of the provisions through
plan design. In addition, some of the provisions will reduce
regulatory burdens on employers that sponsor retirement plans.
The bill includes provisions relating to certain executive
compensation arrangements and the proper tax treatment of such
arrangements. These provisions may impose additional
administrative requirements on employers; however, the employer
may avoid application of the provisions through the design of
these arrangements.
The bill includes various other provisions that are not
expected to impose additional administrative requirements or
regulatory burdens on individuals or businesses.
Impact on personal privacy and paperwork
The provisions of the bill do not impact personal privacy.
Some provisions of the bill relating to pension plans will
reduce paperwork burdens on employers that sponsor qualified
retirement plans. Other provisions may impose additional
burdens on employers; however, in many cases an employer may
reduce such burdens through plan design. The provision
regarding withholding requirements with respect to certain
stock options will reduce regulatory burdens on individuals and
businesses that may currently apply withholding to these
options. Certain provisions provide additional tax benefits to
individuals or businesses, such as the provisions relating to
additional catch-up contributions, the sale of stock to comply
with conflict of interest rules, and exclusions of educational
benefits and group legal services. These provisions may require
individuals and businesses that seek to take advantage of these
tax benefits to maintain records to demonstrate eligibility for
the tax benefits.
B. Unfunded Mandates Statement
This information is provided in accordance with section 423
of the Unfunded Mandates Reform Act of 1995 (P.L. 104-4).
The Committee has determined that the revenue provisions of
the bill do not contain Federal mandates on the private sector.
The Committee has determined that the revenue provisions of the
bill do not impose a Federal intergovernmental mandate on
State, local, or tribal governments.
C. Tax Complexity Analysis
Section 4022(b) of the Internal Revenue Service Reform and
Restructuring Act of 1998 (the ``IRS Reform Act'') requires the
Joint Committee on Taxation (in consultation with the Internal
Revenue Service and the Department of the Treasury) to provide
a tax complexity analysis. The complexity analysis is required
for all legislation reported by the Senate Committee on
Finance, the House Committee on Ways and Means, or any
committee of conference if the legislation includes a provision
that directly or indirectly amends the Internal Revenue Code
(the ``Code'') and has widespread applicability to individuals
or small businesses.
The staff of the Joint Committee on Taxation has determined
that a complexity analysis is not required under section
4022(b) of the IRS Reform Act because the bill contains no
provisions that amend the Code and that have ``widespread
applicability'' to individuals or small businesses.
VI. ADDITIONAL VIEWS
----------
ADDITIONAL VIEWS OF SENATOR CONRAD
I am pleased that as a result of the efforts of Chairman
Grassley, Senator Baucus, other members of the Committee on
Finance, and the Department of the Treasury, the bill includes
a provision on corporate-owned life insurance (COLI) that
preserves COLI as a valuable tool for employers to use in
providing a dependable funding source for their employee
benefit liabilities while at the same time addressing important
concerns that had been expressed about the product.
As a result of the Committee's balanced COLI legislation,
no employer will be able to exclude from income the death
benefits from a policy purchased after enactment on the life of
a rank-and-file employee or on the life of an employee who has
not given informed, voluntary consent to the employer's
purchase of the life insurance. No one will be able to
criticize COLI as ``janitors' insurance'' anymore.
Under the Committee's bill, future COLI purchases will
require that the employer notify the employee in writing that
the employer intends to insure the employee's life and that the
employer will be the beneficiary of the life insurance. The
employer must also disclose to the employee how much the
maximum death benefit under the policy will be at the time of
issuance (i.e., not taking into account normal future death
benefit increases resulting from policy performance, tax rules,
or otherwise). This stronger disclosure rule incorporates a
recommendation that Senator Bingaman and I made to provide
better information to employees whom the employer seeks to
insure.
More importantly, the Committee's bill will also condition
tax-free death benefits from future COLI purchases on the
employee's advance written consent to being insured and to
having the insurance coverage continue after the employee
terminates his or her employment with the employer. The
employee's consent to be insured must, of course, be voluntary.
During its consideration of legislation on COLI, the Committee
learned that there are no known instances of employers coercing
employee consent or retaliating for the failure to provide
consent. However, if such coercion or retaliation were to occur
after enactment of the Committee's COLI provision, I believe
the Congress should consider whether there should be a remedy
in labor law to deter and punish such actions.
I would like to emphasize the importance that I and other
members of the Finance Committee attached to the valuable role
COLI now plays in providing a tool to offset employee benefit
costs, including retiree health promises. The Committee
continues to hear disturbing stories about companies that are
shedding their retiree health liabilities because of cost
concerns.\225\ I hope that continued availability of COLI will
help to slow this trend of retiree health benefit reductions. I
believe the Committee's COLI provision should encourage
employers willing to abide by its clear rules to consider the
purchase of COLI in situations where it would constitute an
appropriate funding mechanism for employee benefit obligations.
\225\ ``Companies Limit Health Coverage of Many Retirees,'' New
York Times, Feb. 3, 2004.
Kent Conrad.
ADDITIONAL VIEWS OF SENATOR BINGAMAN
Although I support the majority of this report, I must
respectfully state my objections to the provisions pertaining
to company owned life insurance (COLI). This language is a
replacement for a meaningful amendment that was originally
negotiated and agreed to by the Committee during the initial
mark up of the bill. Instead of reporting out the bill as
agreed to that day, the Committee kept the bill in limbo for
several months before replacing the COLI provisions agreed upon
by the Committee with alternative language. Unfortunately, this
new language does nothing to curb any of the existing abuses
nor prevent future ones from occurring.
As I have noted previously, the core problem with COLI is
that the uses of this product have moved well beyond what was
ever intended by Congress. The tax benefits associated with
this product--tax free inside buildup and tax-free death
benefits--were intended to aid families and those with a
significant financial risk of loss upon the untimely passing of
the insured. This product is now sold in a variety of
situations where the owners of the policy have little or no
risk of financial loss on the passing of the insured. For
example, companies who take out policies on the lives of
employees routinely keep those policies long after the insured
has left the employment of the company. This occurs even when
the former employee has severed all ties with the company and
is not entitled to any benefit from the company. This was never
the intent of Congress nor does it make for rational tax
policy.
Although companies claim that they purchase the product to
offset the cost of employee benefits, such as retiree health
care, the fact is that companies can use the proceeds of these
tax favored policies for any use. Most commonly, the policies
are used to ``fund'' deferred compensation arrangements or
executive benefits packages--benefits for which Congress has
expressly not provided a tax benefit to businesses. In fact,
Congress has created disincentives in the Tax Code to
discourage the use of these arrangements. For example,
companies are not allowed a deduction for the payment of
deferred compensation until the employee includes the payment
as taxable income.
Congress has explicitly provided tax benefits for employers
to provide employee benefits, such as qualified retirement
plans, health insurance and life insurance owned by the
employee. Unlike COLI, the companies are only eligible to
receive these tax benefits if they take an affirmative act to
provide these benefits to the majority of their employees--not
just the more highly compensated. In most cases, the funds must
be placed in a trust for the benefit of the employee or the
employer must transfer the rights to these benefits to the
employee. Not with COLI. With COLI, a company is able to use
the proceeds of these tax preferenced policies for anything it
chooses. The money is not set aside or dedicated to any
specific use--it is totally up to the discretion of the company
as to how to use the funds. The insured or their beneficiaries
are not entitled to any of these life insurance policies.
Although a company is not required to use the proceeds for
any specific purpose, the product is most often marketed as a
funding mechanism for deferred compensation arrangements or
executive perquisites. Such a use undermines our country's
qualified retirement plan system that is premised on the
concept that employers should receive tax incentives to provide
retirement benefits, but only if the majority of workers can
benefit. COLI competes with this reward system and pushes us
closer to a two-tiered retirement system in this country--one
type of plans for workers and an additional layer of plans for
the executives. Both of these types of plans are subsidized by
all taxpayers, not just the ones that benefit. This is the
wrong approach and it reverses so much of what we have achieved
over the past decades. Ultimately, it makes it more likely that
a large segment of workers will not have adequate savings upon
which to retire. The Committee should be focusing on reducing
this inequity, not allowing it to expand.
The proponents of COLI argue that the language contained in
this report address the abuses in COLI. This can only be true
if one believes that the current uses of COLI are appropriate
tax policy. This is evidenced by the revenue estimate from the
Joint Committee on Taxation that this new provision has a
negligible revenue effect. Essentially this means that the
Joint Committee on Taxation has estimated that there will be no
change in the purchases or uses of this product based on this
language. This is in direct contrast to the original agreed
upon language that would reduce abuses by over $1 billion over
ten years.
Inexplicably, the notice and consent that is required in
this language does little to protect the rights of employees,
as employers are free to fire or not hire employees who do not
wish to give their consent. In almost every other area of labor
law, we provide employees with protections, such as those
contained in ERISA, from retaliatory firings. I offered an
amendment to correct this seemingly clear potential violation
of employee rights, but this amendment was not accepted. I fail
to understand how an employee is better off being dismissed for
not consenting to have an insurance policy taken out on his or
her life than if the company purchased the policy without the
employee's consent. If it was intended that employees' rights
not to consent be truly voluntary, some form of protection
would need to be included.
I also fail to understand the Committee's rationale in
setting up a procedure that can not be enforced by the IRS. The
current language requires a company to have a valid consent in
order to receive the death benefit on the life of the insured
tax free yet the time between the purchase of the policy and
the death of the insured could be years, if not decades. Worse,
the IRS will not even be notified of the death of the insured
or the receipt of the death benefits by the company that owns
the policy. Quite simply, there is no way the IRS will ever be
able to connect these two pieces of information to determine if
a company is in compliance. As the IRS has demonstrated that it
is unable to enforce the myriad laws currently in effect, it is
inconceivable that they will be able to handle these new
responsibilities.
I am confident that the issues I have raised will need to
be addressed in the future by this Committee. The tax benefits
associated with COLI are simply too great to be ignored as
evidenced by current abuses. As this report is being filed,
stories are already circulating evidencing additional abuses
with charities and churches buying COLI policies and selling
them to investors. It is important to note that nothing in this
report will have an impact on these types of policies. With
deficits continuing to climb, I assume that this Committee will
eventually need to make real choices about tax policy. At that
point, I look forward to working with the insurance industry
and my colleagues to come up with a rational policy that allows
life insurance to continue to prosper, but in a way that does
not foster such abuses.
Jeff Bingaman.
VII. CHANGES IN EXISTING LAW MADE BY THE BILL AS REPORTED
In the opinion of the Committee, it is necessary in order
to expedite the business of the Senate, to dispense with the
requirements of paragraph 12 of rule XXVI of the Standing Rules
of the Senate (relating to the showing of changes in existing
law made by the bill as reported by the Committee).