One might be led to believe that the current administration is in favor of expanding retirement savings opportunities. After all, the DOL has somewhat apologetically subverted ERISA to allow the States to sponsor employer-based savings plans. And the President’s recently proposed budget endeavors to provide a national retirement savings program. (See page 135 of the General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals) So why then would the IRS reverse two decades of regulation that favors cross-tested plans in small businesses, an action that might cause many small employers to terminate their qualified plans or amend them to reduce the employer contribution to employee’s accounts?
Some background may be in order. Cross-tested defined contribution plans are allowed to test equivalent benefit accrual rate (EBAR) groups separately using the ratio percentage test or the average benefits test. Unlike testing for coverage, application of the average benefits test here does not include testing for a reasonable business classification. This has permitted cross-tested plans to create small rate groups each of which meets the modified average benefits test and permits greater relative nonelective contribution (NEC) amounts for HCEs. Typically, the average benefits test for cross-testing finds that the EBARs for HCEs are the same or less than the EBARs for NHCEs. Notwithstanding this EBAR comparison, this allows for a sizeable difference in nonelective contribution allocation rates that benefit the HCEs who are often older and certainly more highly compensated. To take advantage of this otherwise seeming-to-discriminate structure, the plan must provide a gateway NEC of at least 5% of compensation for all eligible NHCEs, a rather generous employer minimum contribution. This trade-off was seen as a fair differentiation that would allow small business owners the opportunity to “skew” contribution allocation rates in their favor while at the same time providing their employees with a meaningful account addition. This has led to adoption of thousands of cross-tested plans benefitting many NHCEs around the country.
The proposed rule upends the trade-off. By adding the reasonable business classification requirement to the average benefits test for cross-testing purposes (and, of course, leaving the gateway contribution in place), the IRS, in proposed regulation §1.401(a)(4)-13, will force many cross-tested plans to use the ratio percentage test at a far greater cost since the small rate group approach will be eliminated. That will require an increase in the EBARs for the NHCEs in order for a larger rate group to pass the ratio percentage test if the EBAR for the specified HCE is static. That will require a greater NEC for NHCEs, an increased cost that many small businesses simply cannot afford or will not want to contribute for other business reasons (like the high cost of health insurance). And the average benefits test will not be palatable since small rate groups that often include only one NHCE will not be based on a reasonable business classification. A reasonable business classification is based on “all the facts and circumstances . . ., is reasonable and is established under objective business criteria that identify the category of employees who benefit under the plan. Reasonable classifications generally include specified job categories, nature of compensation (i.e., salaried or hourly), geographic location, and similar bona fide business criteria. An enumeration of employees by name or other specific criteria having substantially the same effect as enumeration by name is not considered a reasonable classification.” Treas. Reg. §1.410(b)-4(b). Of course, a “facts and circumstances” test often presents an unknown, one that small businesses are not likely to embrace.
So, why, after all these years, would the IRS change the rule to make it more expensive to sponsor a cross-tested plan, possibly causing many small employers to amend their plans to eliminate NECs or even terminate their plans? The answer may lie in looking at who most adopts these plans. Although there are no available statistics, it is commonly understood that many, possibly the majority of, cross-tested plans have been adopted by professional practices including those dastardly doctors and lawyers, seemingly high earners that the IRS may believe want nothing more than to take advantage of their employees. If the rule is finalized, the affect will likely be a reduction in the size of employer contributions to the accounts of those NHCEs fortunate enough to be participants in cross-tested plans. The impact of the new rule would seem to be contrary to the policy goal of expanding coverage for NHCEs. When looking at annual contribution limits under current law and the President’s goal of limiting the size of a tax-favored account (see the Proposal beginning on page 167 of the General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals) that would prevent the doctors and lawyers from getting a perceived too large a share of the tax advantage, it doesn’t seem to make policy sense to disrupt a plan structure that provides the gateway contribution for NHCEs.
Update: If you want to contact Treasury or your Congressional representative to tell them what you think of this change, you can go to http://savemyplan.org/.
The Department of Labor (“DOL”) has recently implemented an initiative to investigate the manner in which defined benefit plans of large employers comply with the required minimum distribution rules set forth in Section 401(a)(9) of the Internal Revenue Code (“Code”). The initiative is focused on the extent to which large employers have processes in place to (i) locate missing plan participants, (ii) inform deferred vested participants that a benefit is payable, and (iii) commence benefit payments in a timely fashion by each participant’s “required beginning date” (generally, the April 1 following the later of the calendar year in which the participant reaches age 70½ or the calendar year in which the participant terminates employment).
In light of the DOL’s audit initiative, employers will want to assure that they have procedures in place to (i) locate missing plan participants, (ii) inform terminated vested participants regarding their right to elect benefits, and (iii) commence benefit payments on or before each participant’s required beginning date. In addition, employers will want to confirm that such procedures are consistently followed in practice, and that documentary evidence regarding compliance is being maintained and preserved. For example, employers will want to retain evidence of all certified mailings to terminated vested participants and lost participants, as well as efforts made through locator services to locate lost participants.
Outside of audit concerns, implementing and consistently following such procedures may help to minimize the risk that participants will be faced with excise taxes for not having their required minimum distributions timely distributed. Under Section 4974 of the Code, any participant who is not paid his or her required minimum distribution for a given year may be liable for an excise tax equal to 50% of amount that should have been paid out as a required minimum distribution for the year. Although this excise tax has been around for quite some time, it may be (unwelcome) news to participants who are past their required beginning dates. If, after implementing procedures, it is determined that there are participants who are delinquent on their required minimum distributions, an employer may be able to correct these missed distributions through the IRS’s Employee Plans Compliance Resolution System (“EPRCS”) and have the excise tax waived by the IRS.
ALERT, ALERT!!!! The IRS has renewed a consumer alert for e-mail schemes regarding phishing and malware incidents targeted at individuals. That renewal came after an approximate 400 percent surge in such incidents so far this tax season. The 400 percent surge was not the end of the phishing schemes this tax season, and now a phishing scheme is emerging to target payroll and HR.
The IRS has also issued a second alert to warn about additional scams this tax season which are designed to trick HR and payroll professionals to provide personal information on employees. Unlike prior scams, the e-mails are no longer just designed to trick taxpayers into thinking the IRS is attempting to contact them for personal information. This latest phishing scheme is a variation known as a “spoofing” e-mail crafted to look as though it came from within the company being targeted – e.g., company executives.
A common example described in the most recent alert indicates that the e-mail will use the actual name of the company chief executive officer so that the email appears to be from the “CEO” to a company payroll office employee. The “CEO” will ask that the employee provide a variety of personal information for “review”. Some of the reported requests include:
- Kindly send me the individual 2015 W-2 (PDF) and earnings summary of all W-2 of our company staff for a quick review.
- Can you send me the updated list of employees with full details (name, social security number, date of birth, home address, salary) as at 2/2/2016?
- I want you to send me the list of W-2 copy of employees wage and tax statement for 2015, I need them in PDF file type, you can send it as an attachment. Kindly prepare the lists and email them to me ASAP.
IRS Criminal Investigation is already reviewing several cases in which people have been tricked into sharing SSNs with what turned out to be cybercriminals.
Payroll and HR professionals need to be vigilant this tax season, because now those phishing hope to lure you into providing them with sensitive employee information. When in doubt, politely verify the request before forwarding sensitive information, including W-2s, filing status and PIN information.
A few weeks ago, the President released his proposed budget for the fiscal year 2017. As usual, it is dense. However, the President has suggested some changes to employee benefits that are worth noting. While they are unlikely to get too much traction in an election year, it is useful to keep them in mind as various bills wind their way through Congress to see what the President might support.
- Auto-IRAs. Stop us if you’ve heard this one before. The proposal would require every employer with more than 10 employees that does not offer a retirement plan to automatically enroll workers in an IRA. No employer contribution would be required and, of course, individuals could choose not to contribute. (In case you’ve forgotten, we’ve seen this before.)
- Tax Credits for Retirement Plans. Employers with 100 or fewer employees who “offer” an auto-IRA (note the euphemistic phrasing in light of the first proposal) would be eligible for a tax credit up to $4,500. The existing startup credit for new retirement plans would also be tripled. Small employers who have a plan, but add automatic enrollment would also be eligible for a $1,500 tax credit.
- Change in Eligibility for Part-Timers. The budget would require part-time workers who work 500 hours per year for three consecutive years to be made eligible for a retirement plan.
- Spending Money to Help Save Money. The President proposes to set aside $6.5 million to encourage State-based retirement plans for private sector workers.
- Opening Up MEPs. To help level the playing field with the State-run plans, the budget proposes to remove the requirement that employers have a common bond to participate in a multiple employer plan (MEP). This is a proposal that has already been floated by Sen. Orrin Hatch, so there’s some possibility that, even in an election year, this might get passed (probably, if not mostly, because it would be hard for anyone to have a vote for open MEPs used against them on the campaign trail given that so few outside the retirement space even know what they are).
- More Leakage For Long-Term Unemployed. The budget also proposes to allow long-term unemployed individuals to withdraw up to $50,000 per year for two years from tax-favored accounts. This proposal, if implemented, would be interesting to study empirically. Obviously, it would lead to more leakage from retirement plans, but would people be more apt to contribute knowing that they could withdraw if they really needed to do so?
- Double-tax of Retirement Benefits? In what appears to be a repeat of a prior proposal, page 50 of the budget summary states that the value of “Other Tax Preferences” (not specified) would be limited to 28 percent. This would seem to describe the President’s proposal from prior years that to the tax benefit of retirement plan contributions (among other items). However, such a proposal is, in our view, counter-intuitive given the other proposals to expand retirement access.
- Cadillac Tax Would Get a Tune-Up. The ACA tax on high-cost coverage would change the thresholds that determine when the tax applies. Currently, there is one threshold for self-only coverage and another for coverage other than self-only coverage. The budget would propose to change the thresholds to the higher of those amounts or the average premium for a gold plan in the ACA Marketplace in each state. This is designed to help address geographic variations in the cost of coverage. There is also a mention in the summary of making it easier for employers with flexible spending arrangements to calculate the tax, but it is not clear what form that would take.
- Miscellaneous. In the budget tables, there are also a few benefits items, such as:
- Expanding and simplifying the small employer tax credit for employer contributions to health insurance (page 148).
- Simplifying the required minimum distribution rules (page 152).
- Taxing carried interests / profits interests as ordinary income (page 153).
- Requiring non-spousal beneficiaries of deceased IRA owners and retirement plan participants to take inherited distributions over no more than five years (page 153).
- Capping the total accrual of tax-favored retirement benefits (which seems like another repeat of prior proposals – page 153).
- Limiting Roth conversions to pre-tax dollars (page 153).
- Eliminating the deduction for dividends on stock in ESOPs of publicly-traded companies (page 153).
- Repealing the exclusion of net unrealized appreciation for certain distributions of employer securities from qualified retirement plans (page 153).
A summary of these changes from the Administration is available here (along with a few other items). More on the overall budget is available here. Do you have additional details, other information, or a point of view on these proposals? Post it in the comments!