Employee Benefits

Employee Benefits Developments February 2005

Rulings, Opinions, Etc.

HSAs for Partners and S Corporation Shareholders. Is your partnership or S corporation interested in setting up a high-deductible health plan so you and your employees can take advantage of tax deductible Health Savings Accounts (HSAs)? The Internal Revenue Service (IRS) issued a notice explaining the operation of HSAs for partners and S corporation shareholders. Generally, contributions by a partnership or an S corporation to an HSA of a partner or shareholder will be included in the income of the partner or shareholder. The contribution amounts will avoid self-employment or FICA taxes if the HSA is set up properly, and the individual will be entitled to deduct the contribution as an adjustment to gross income on his or her tax return. IRS Notice 2005-8

Regulations Eliminating Optional Forms of Distribution Finalized. Regulations allowing a defined contribution plan (e.g., an Internal Revenue Code (IRC) § 401(k) or profit sharing plan) to eliminate installment, annuity, and other forms of payment have been finalized. Optional forms of benefit distribution may be eliminated if the plan contains a single lump sum distribution option. One notable exception is that a money purchase plan cannot eliminate joint and survivor annuities. The final regulations complete the elimination of a 90-day notice requirement that was previously required but eliminated by legislation in 2001. With these regulations in place and effective January 25, 2005, plans with available lump sum options may remove optional forms of payment by amendment without providing advance notice to participants. T.D. 9176, 70 Fed. Reg. 3475 (January 25, 2005)

Proposed Change to Effective Date of Final Regulations Regarding QJSA Explanations. In January, the IRS proposed regulations that would change the effective date of the final “relative value” regulations that were reported in previous editions of Employee Benefits Developments. The “relative value” regulations specify requirements for disclosing the relative value of optional forms of benefits under certain retirement plans. The proposed regulations would modify the “relative value” regulations to provide that the “relative value” regulations are generally effective for qualified joint and survivor annuity (“QJSA”) explanations provided with respect to annuity starting dates beginning after January 31, 2006. The proposed regulations also contain certain clarifications of the QJSA explanation requirements relating to the use of reasonable estimates, disclosing participant-specific information in the place where generally-applicable information would normally appear, and calculations using interest and mortality rate assumptions.

The earlier effective date of October 1, 2004 is still applicable for QJSA explanations relating to single sums, installment payments, and benefit forms that are partially single sums or partially installment payments, if those sums or payments are less valuable than the QJSA. IRS Prop. Reg. §§ 1.401(a)-20 and 1.417(a)(3)-1 (70 Fed. Reg. 4058 (Jan. 28, 2005))

Reporting Income Under Plans That Fail to Meet IRC § 409A. The IRS further modified the 2005 Form W-2 to accommodate new reporting requirements for nonqualified deferred compensation, as mandated under IRC § 409A, which was added to the IRC by the American Jobs Creation Act of 2004. The IRS announced previously that a new Code Y should be used for reporting annual deferrals under a nonqualified deferred compensation plan, regardless of whether the amounts are included in taxable income in the year deferred. Now, a new Code Z has been added to box 12 of the Form W-2 for identifying income recognized as a result of participation in a nonqualified deferred compensation plan that fails to meet the requirements of IRC § 409A. This amount is subject to interest and an additional 20% penalty. The income recognized is also included in box 1, under “Wages, tips, other compensation.” Social Security and Medicare wage reporting does not change under the new law. Income recognized under IRC § 409A for nonemployees is reported in boxes 7 and 15b of Form 1099-MISC. Announcement 2005-5

Get Your Retiree Prescription Drug Subsidy Here! The Centers for Medicare & Medicaid Services (CMS) issued final regulations governing the new Medicare Part D prescription drug benefit. These regulations implement the 2003 Medicare reform law establishing a prescription drug benefit for Medicare beneficiaries in 2006. Under the law, employers who offer retiree drug coverage as good as or better than Medicare’s new Part D drug coverage can receive a tax-free subsidy payment from the federal government. This subsidy is to encourage employers offering retiree drug coverage to continue such coverage rather than eliminating benefits when Medicare Part D becomes available in 2006. These final regulations address a criticism that the proposed rules could create a windfall in certain situations where the subsidy would exceed the employers actual contribution for retiree drug coverage. Under the final regulations, in order to receive the subsidy, employers must show, on an actuarial basis, the prescription drug coverage is as good or better than Medicare Part D coverage. Additionally, employers must also show that their contributions to the prescription drug coverage is as valuable as the Medicare Part D coverage. Employers wishing to pursue the retiree drug subsidy should pay special attention to these rules. Application for subsidies in 2006 must be made by September 2005. Additional information can be found at the CMS website at www.cms.hhs.gov/medicarereform/pdbma/employer.asp.

Cases

Ex-Con Still Disabled, Despite Prison Jobs. Donald Dover, a participant in IBM’s long term disability plan, suffered a psychiatric disability and began to receive plan benefits. Three years later, Dover was arrested for bad check writing and loan application fraud, resulting in an involuntary 78-month holiday at two Federal Correction Institutions in Minnesota. Metropolitan Life Insurance Company, the claims administrator of IBM’s plan, determined Dover’s condition improved in prison to the degree that he could once again work, offering as proof for its contention Dover’s tenure as an electric helper in the prison’s electric shop. The benefits were discontinued, Dover appealed the determination, and was subsequently released from prison. A lengthy court battle ensued, culminating in a decision by the U.S. Court of Appeals for the Sixth Circuit. Following an examination of Dover’s prison work record, the federal appellate court held Metropolitan’s determination to be “arbitrary and capricious,” finding that the “type of highly structured and supervised work in a prison, dramatically limited by Dover’s continuing treatments for his mental disability, could [not] rationally be considered sufficient evidence of an ability to perform the duties of gainful employment.” Dover v. Metropolitan Life Insurance Company (6th Cir. 2005)

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