[Federal Register Volume 66, Number 4 (Friday, January 5, 2001)]
[Proposed Rules]
[Pages 1066-1069]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-249]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-116468-00]
RIN 1545-AY43


Minimum Cost Requirement Permitting the Transfer of Excess Assets 
of a Defined Benefit Pension Plan to a Retiree Health Account

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed Income Tax Regulations 
relating to the minimum cost requirement under section 420, which 
permits the transfer of excess assets of a defined benefit pension plan 
to a retiree health account. Pursuant to section 420(c)(3)(E), these 
proposed regulations provide that an employer who significantly reduces 
retiree health coverage during the cost maintenance period does not 
satisfy the minimum cost requirement of section 420(c)(3). In addition, 
these proposed regulations clarify the circumstances under which an 
employer is considered to have significantly reduced retiree health 
coverage during the cost maintenance period. This document also 
provides a notice of public hearing on these regulations.

DATES: Written or electronic comments must be received by March 6, 
2001. Requests to speak (with outlines of oral comments to be 
discussed) at the public hearing scheduled for March 15, 2001, must be 
received by February 21, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (REG-116468-00), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU (REG-116468-00), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
NW., Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
Internet site at http://www.irs.gov/tax__regs/regslist.html.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Vernon S. 
Carter or Janet A. Laufer, (202) 622-6060; concerning submissions, 
Treena Garrett, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    The Revenue Reconciliation Act of 1990 (Pub. L. 101-508)(104 Stat. 
1388), section 12011, added section 420 of the Internal Revenue Code 
(Code), a temporary provision permitting certain qualified transfers of 
excess pension assets from a non-multiemployer defined benefit pension 
plan to a health benefits account (defined as an account established 
and maintained under section 401(h) of the Code (401(h) account)) that 
is part of the plan.\1\ One of the conditions of a qualified section 
420 transfer was that the employer satisfy a maintenance of effort 
requirement in the form of a ``minimum cost requirement'' under which 
the employer was required to maintain employer-provided retiree health 
expenditures for covered retirees, their spouses, and dependents at a 
minimum dollar level for a 5-year cost maintenance period, beginning 
with the taxable year in which the qualified transfer occurs.
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    \1\ Section 420(a)(1) and (2) provide that the trust that is 
part of the plan is not treated as failing to satisfy the 
qualification requirements of section 401 (a) or (h) of the Code, 
and no amount is includable in the gross income of the employer 
maintaining the plan, solely by reason of such transfer. Also, 
section 420(a)(3) provides that a qualified transfer is not treated 
as either an employer reversion for purposes of section 4980 or a 
prohibited transaction for purposes of section 4975.
    In addition, Title I of the Employee Retirement Income Security 
Act of 1974 (88 Stat. 829), as amended (ERISA), provides that a 
qualified transfer pursuant to section 420 is not a prohibited 
transaction under ERISA (ERISA section 408(b)(13)) or a prohibited 
reversion of assets to the employer (ERISA section 403(c)(1)). ERISA 
also provides certain notification requirements with respect to such 
qualified transfers.
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    The Uruguay Round Agreements Act (Pub. L. 103-465)(108 Stat. 4809)

[[Page 1067]]

(December 8, 1994), extended the availability of section 420 through 
December 31, 2000. In conjunction with the extension, Congress modified 
the maintenance of effort rules for plans transferring assets for 
retiree health benefits so that employers could take into account cost 
savings realized in their health benefit plans. As a result, the focus 
of the maintenance of effort requirement was shifted from health costs 
to health benefits. Under this ``benefit maintenance requirement,'' 
which applied to qualified transfers made after December 8, 1994, an 
employer had to maintain substantially the same level of employer-
provided retiree health coverage for the taxable year of the transfer 
and the following 4 years. The level of coverage required to be 
maintained was based on the coverage provided in the taxable year 
immediately preceding the taxable year of the transfer.
    The Tax Relief Extension Act of 1999 (title V of H.R. 1180, the 
Ticket to Work and Work Incentives Improvement Act of 1999) (Pub. L. 
106-170,113 Stat 1860) (TREA-99) extended section 420 through December 
31, 2005. In conjunction with this extension, the minimum cost 
requirement was reinstated as the applicable ``maintenance of effort'' 
provision (in lieu of requiring the maintenance of the level of 
coverage) for qualified transfers made after December 17, 1999. Because 
the minimum cost requirement relates to per capita cost, an employer 
could satisfy minimum cost requirement by maintaining the average cost 
even though the employer defeats the purpose of the maintenance of 
effort requirement by reducing the number of people covered by the 
health plan. In response to concerns regarding this possibility, TREA-
99 also added section 420(c)(3)(E), which requires the Secretary of the 
Treasury to prescribe such regulations as may be necessary to prevent 
an employer who significantly reduces retiree health coverage during 
the cost maintenance period from being treated as satisfying the 
minimum cost requirement of section 420(c)(3). If the minimum cost 
requirement of section 420(c)(3) is not satisfied, the transfer of 
assets from the pension plan to the 401(h) account is not a ``qualified 
transfer'' to which the provisions of section 420(a) apply.

Explanation of Provisions

    These proposed regulations would provide that the minimum cost 
requirement of section 420(c)(3) is not met if the employer 
significantly reduces retiree health coverage during the cost 
maintenance period. The proposed regulations would measure whether this 
occurs by looking at the number of individuals (retirees, their 
spouses, and dependents) who lose coverage during the cost maintenance 
period as a result of employer actions, measured on both an annual 
basis and a cumulative basis.
    In determining whether an employer has significantly reduced 
retiree health coverage, the regulations would provide that the 
employer does not satisfy the minimum cost requirement if the 
percentage decrease in the number of individuals provided with 
applicable health benefits that is attributable to employer action 
exceeds 10% in any year, or if the sum of the annual percentage 
decreases during the cost maintenance period exceeds 20%. The 10% 
annual limit would not apply to a taxable year that begins before 
February 5, 2001.
    The regulations would provide a broad definition of employer 
action, including not only plan amendments but also situations in which 
other employer actions, such as the sale of all or part of the 
employer's business, operate in conjunction with the existing plan 
terms to have the indirect effect of ending an individual's coverage. 
The definition of employer action would include plan amendments that 
are executed before the cost maintenance period but take effect during 
the cost maintenance period, unless the amendment occurred before the 
later of December 18, 1999, and 5 years before the start of the cost 
maintenance period.
    The regulations contain a special rule that addresses situations in 
which an employer adopts plan terms that establish eligibility for 
health coverage for some individuals, but provide that those same 
individuals lose health coverage upon the occurrence of a particular 
event or after a stated period of time. In those cases, an individual 
is not counted as having lost health coverage by reason of employer 
action merely because that individual's coverage ends upon the 
occurrence of the event or after the stated period of time.
    Under the proposed regulation, when an individual's coverage ends 
by reason of a sale of all or part of the employer's business, the 
individual is counted as an individual losing coverage by reason of 
employer action. The proposed regulation contains no exceptions from 
this rule even if the buyer provides coverage for such individuals (on 
the implicit assumption that the buyer rarely undertakes to provide 
such coverage to retirees in these transactions). Comments are 
specifically requested as to (1) the circumstances, if any, in which 
buyers commonly provide the seller's retirees, and their spouses and 
dependents, with health coverage following a corporate transaction, and 
(2) in such cases, criteria that should apply to the replacement 
coverage in determining whether to treat those individuals as not 
having lost coverage.

Proposed Effective Date

    The regulations are proposed to be applicable to transfers of 
excess pension assets on or after December 18, 1999.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and, because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and (8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and Treasury Department specifically request comments on 
the clarity of the proposed rule and how it may be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for March 15, 2001, beginning 
at 10 a.m. in the IRS Auditorium, Seventh Floor, Internal Revenue 
Service, 1111 Constitution Avenue, NW., Washington, DC. Due to building 
security procedures, visitors must enter at the 10th Street entrance, 
located between Constitution and Pennsylvania Avenues, NW. In addition, 
all visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT portion of this preamble.

[[Page 1068]]

    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments must submit written comments and an 
outline of the topics to be discussed and time to be devoted to each 
topic (a signed original and eight (8) copies) by February 21, 2001. A 
period of 10 minutes will be allotted to each person for making 
comments. An agenda showing the scheduling of the speakers will be 
prepared after the deadline for receiving outlines has passed. Copies 
of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Vernon S. Carter and 
Janet A. Laufer, Office of Division Counsel/Associate Chief Counsel 
(Tax Exempt and Government Entities). However, other personnel from the 
IRS and Treasury Department participated in their development.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
a new entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805, 26 U.S.C. 420(c)(3)(E) * * *

    Par. 2. Section 1.420-1 is added to read as follows:


Sec. 1.420-1  Significant reduction in retiree health coverage during 
the cost maintenance period.

    (a) In general. Notwithstanding section 420(c)(3)(A), the minimum 
cost requirements of section 420(c)(3) are not met if the employer 
significantly reduces retiree health coverage during the cost 
maintenance period.
    (b) Significant reduction--(1) In general. An employer 
significantly reduces retiree health coverage during the cost 
maintenance period if, for any taxable year during the cost maintenance 
period, either --
    (i) The employer-initiated reduction percentage for that taxable 
year exceeds 10%; or
    (ii) The sum of the employer-initiated reduction percentages for 
that taxable year and all prior taxable years during the cost 
maintenance period exceeds 20%.
    (2) Special rule for certain taxable years. Notwithstanding 
paragraph (b)(1)(i) of this section, an employer will not be treated as 
significantly reducing retiree health coverage for a taxable year that 
begins before February 5, 2001, merely because the employer-initiated 
reduction percentage for that taxable year exceeds 10%.
    (3) Employer-initiated reduction percentage. The employer-initiated 
reduction percentage for any taxable year is the fraction B/A, 
expressed as a percentage, where

A = The total number of individuals (retired employees plus their 
spouses plus their dependents) receiving coverage for applicable 
health benefits as of the day before the first day of the taxable 
year.
B = The total number of individuals included in A whose coverage for 
applicable health benefits ended during the taxable year by reason 
of employer action.

    (4) Employer action--(i) General rule. For purposes of paragraph 
(b)(3) of this section, an individual's coverage for applicable health 
benefits ends during a taxable year by reason of employer action, if on 
any day within the taxable year, the individual's eligibility for 
applicable health benefits ends as a result of a plan amendment or any 
other action of the employer (e.g., the sale of all or part of the 
employer's business) that, in conjunction with the plan terms, has the 
effect of ending the individual's eligibility. An employer action is 
taken into account for this purpose regardless of when the employer 
action actually occurs (e.g., the date the plan amendment is executed), 
except that employer actions occurring before the later of December 18, 
1999, and the date that is 5 years before the start of the cost 
maintenance period are disregarded.
    (ii) Special rule. Notwithstanding paragraph (b)(4)(i) of this 
section, coverage for an individual will not be treated as having ended 
by reason of employer action merely because such coverage ends under 
the terms of the plan if those terms were adopted contemporaneously 
with the provision under which the individual became eligible for 
retiree health coverage.
    (c) Definitions. The following definitions apply for purposes of 
this section:
    (1) Applicable health benefits. Applicable health benefits means 
applicable health benefits as defined in section 420(e)(1)(C).
    (2) Cost maintenance period. Cost maintenance period means the cost 
maintenance period as defined in section 420(c)(3)(D).
    (d) Examples. The following examples illustrate the application of 
this section:

    Example 1. (i) Employer W maintains a defined benefit pension 
plan that includes a 401(h) account and permits qualified transfers 
that satisfy section 420. The number of individuals receiving 
coverage for applicable health benefits as of the day before the 
first day of Year 1 is 100. In Year 1, Employer W makes a qualified 
transfer under section 420. There is no change in the number of 
individuals receiving health benefits during Year 1. As of the last 
day of Year 2, applicable health benefits are provided to 99 
individuals, because 2 individuals became eligible for coverage due 
to retirement and 3 individuals died in Year 2. During Year 3, 
Employer W amends its health plan to eliminate coverage for 5 
individuals, 1 new retiree becomes eligible for coverage and an 
additional 3 individuals are no longer covered due to their own 
decision to drop coverage. Thus, as of the last day of Year 3, 
applicable health benefits are provided to 92 individuals. During 
Year 4, Employer W amends its health plan to eliminate coverage 
under its health plan for 8 more individuals, so that as of the last 
day of Year 4, applicable health benefits are provided to 84 
individuals. During Year 5, Employer W amends its health plan to 
eliminate coverage for 8 more individuals.
    (ii) There is no significant reduction in retiree health 
coverage in either Year 1 or Year 2, because there is no reduction 
in health coverage as a result of employer action in those years.
    (iii) There is no significant reduction in Year 3. The number of 
individuals whose health coverage ended during Year 3 by reason of 
employer action (amendment of the plan) is 5. Since the number of 
individuals receiving coverage for applicable health benefits as of 
the last day of Year 2 is 99, the employer-initiated reduction 
percentage for Year 3 is 5.05% (5/99), which is less than the 10% 
annual limit.
    (iv) There is no significant reduction in Year 4. The number of 
individuals whose health coverage ended during Year 4 by reason of 
employer action is 8. Since the number of individuals receiving 
coverage for applicable health benefits as of the last day of Year 3 
is 92, the employer-initiated reduction percentage for Year 4 is 
8.70% (8/92), which is less than the 10% annual limit. The sum of 
the employer-initiated reduction percentages for Year 3 and Year 4 
is 13.75%, which is less than the 20% cumulative limit.
    (v) In Year 5, there is a significant reduction under paragraph 
(b)(1)(ii) of this section. The number of individuals whose health 
coverage ended during Year 5 by reason of employer action (amendment 
of the plan) is 8. Since the number of individuals receiving 
coverage for applicable health benefits as of the last day of Year 4 
is 84, the employer-initiated reduction percentage for Year 5 is 
9.52% (8/84), which is less than the 10% annual limit. However, the 
sum of the employer-initiated reduction percentages for Year 3, Year 
4, and Year 5 is 5.05% + 8.70% + 9.52% = 23.27%, which exceeds the 
20% cumulative limit.
    Example 2. (i) Employer X maintains a defined benefit pension 
plan that includes a 401(h) account and permits qualified transfers 
that satisfy section 420. X also provides lifetime health benefits 
to employees who retire from Division A as a result of a plant 
shutdown, no health benefits to employees who retire from Division 
B, and lifetime health benefits to all employees who

[[Page 1069]]

retire from Division C. In 2000, X amends its health plan to provide 
coverage for employees who retire from Division B as a result of a 
plant shutdown, but only for the 2-year period coinciding with their 
severance pay. Also in 2000, X amends the health plan to provide 
that employees who retire from Division A as a result of a plant 
shutdown receive health coverage only for the 2-year period 
coinciding with their severance pay. A plant shutdown that affects 
Division A and Division B employees occurs in 2000. The number of 
individuals receiving coverage for applicable health benefits as of 
the last day of 2001 is 200. In 2002, Employer X makes a qualified 
transfer under section 420. As of the last day of 2002, applicable 
health benefits are provided to 170 individuals, because the 2-year 
period of benefits ends for 10 employees who retired from Division A 
and 20 employees who retired from Division B as a result of the 
plant shutdown that occurred in 2000.
    (ii) There is no significant reduction in retiree health 
coverage in 2002. Coverage for the 10 retirees from Division A who 
lose coverage as a result of the end of the 2-year period is treated 
as having ended by reason of employer action, because coverage for 
those Division A retirees ended by reason of a plan amendment made 
after December 17, 1999. However, the terms of the health plan that 
limit coverage for employees who retired from Division B as a result 
of the 2000 plant shutdown (to the 2-year period) were adopted 
contemporaneously with the provision under which those employees 
became eligible for retiree coverage under the health plan. 
Accordingly, under the rule provided in paragraph (b)(4)(ii) of this 
section, coverage for those 20 retirees from Division B is not 
treated as having ended by reason of employer action. Thus, the 
number of individuals whose health benefits ended by reason of 
employer action in 2002 is 10. Since the number of individuals 
receiving coverage for applicable health benefits as of the last day 
of 2001 is 200, the employer-initiated reduction percentage for 2002 
is 5% (10/200), which is less than the 10% annual limit.

    (e) Effective date. This section is applicable December 18, 1999, 
for qualified transfers occurring on or after that date.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 01-249 Filed 1-4-01; 8:45 am]
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