Employee Benefits

Employee Benefits Developments November 2005

HOT TOPICS

IRS and Social Security Announce 2006 Limits. The annual cost of living adjustments to certain employee benefit limitations have been announced by the Internal Revenue Service (IRS) and Social Security Administration. Some of the key limits are listed below:

401(k)/403(b)/457 maximum annual deferral	$15,000
401(k)/403(b)/457 Catch-up amount	$5,000
Defined contribution maximum annual addition	$44,000
Defined benefit annual pension—maximum	$175,000
Plan compensation limit	$220,000
Social Security Taxable Wage Base	$94,200

A more complete listing of limitations for 2006 and prior years can be found on our website at www.hodgsonruss.com/document_418.html.

Safe Harbor 401(k) Plan Notices—New Content Rules Apply. Internal Revenue Code (IRC) § 401(k) plans providing “safe harbor” employer contributions are treated as satisfying the ADP test provided each eligible employee is given a written notice that describes, among other things, the plan’s safe harbor employer contribution formula and the distribution events and vesting schedules for all plan contributions.

Before the final 401(k) regulations were issued, safe harbor notices were not required to explain vesting and distribution rules if these rules were explained in the plan’s SPD, as long as the safe harbor notice contained a reference to the relevant provisions of the SPD. Under final 401(k) regulations, a plan’s vesting and distribution rules must be described in the safe harbor notice; it appears that reference to the SPD is no longer sufficient.

Safe harbor notices for plan years beginning on or after January 1, 2007 should explain plan vesting and distribution rules rather than simply refer participants to relevant sections of the plan’s SPD. For plan years beginning before 2007, a safe harbor 401(k) plan will not fail to satisfy the notice requirement merely because the notice cross-references the plan’s SPD. IRS Notice 2005-95.

Affected employers should note that safe harbor notices must be provided within a reasonable period before the beginning of each plan year. Notices furnished at least 30 days and not more than 90 days before the beginning of the plan year are deemed to meet this requirement. Employees who become eligible after the annual notice is furnished must receive an individual notice within the 90-day period ending on the date he or she becomes eligible.

RULINGS, OPINIONS, ETC.

IRS Issues Guidance on FSA Grace Period and HSA Eligibility. IRS Notice 2005-86, issued November 22, 2005, clarifies the following points about the two-and-a-half-month Flexible Spending Account (FSA) grace period:

the grace period must not extend beyond the 15th day of the third calendar month after the end of the preceding plan year (e.g., March 15, 2006, for plan years ending December 31, 2005) but a shorter period is permitted;
the grace period must be available to all participants who are covered on the last day of the FSA plan year, including former employees covered under COBRA;
if a plan offers both health and dependent care FSAs, the grace period may be adopted for one (e.g. dependent care FSA) and not the other;
participants who terminate employment during the grace period, must have the full grace period to request reimbursement.

IRS Notice 2005-86 also clarifies the interaction of the two-and-a-half-month FSA grace period and eligibility to contribute to health savings accounts (HSAs). Under the new guidance, if an individual is enrolled in a general purpose health FSA that includes a grace period, the individual is not eligible to contribute to an HSA during the grace period. This restriction does not apply if an employer maintains a limited purpose health FSA (e.g., limited to vision and dental) or post-deductible health FSA (i.e., limited to expenses incurred after the high-deductible health plan deductible is exhausted). Accordingly, an employer can convert its general purpose health FSA into a limited purpose health or post-deductible FSA and thereby enable employees covered by the FSA to make full-year HSA contributions.

Example: Acme, Inc. maintains a calendar year high deductible health plan and a calendar year general purpose health FSA with a grace period ending March 15. Smith enrolls in Acme’s high deductible health plan effective January 1, 2007. Smith does not enroll in the health FSA for 2007. However, Smith was covered under Acme’s health FSA during 2006 and will be covered throughout the grace period ending March 15, 2007 even though Smith’s FSA balance as of the end of the preceding plan year was zero. Smith is not eligible for an HSA contribution until April 1, 2007, because Smith was covered under the health FSA grace period through March 15, 2007.
Transition relief applies for health FSA plan years ending before June 5, 2006. For example, under the transition rule, an individual participating in a general purpose calendar year health FSA for 2005 is eligible to make HSA contributions effective January 1, 2006, if the individual’s health FSA has a zero balance as of the end of 2005, or the employer’s health FSA plan document provides that the grace period is not available to any individual who elects high deductible health plan coverage.

IRS Announces Abusive Deal Settlement Program. On October 27, 2005, the IRS unveiled an expansive tax shelter settlement program. Under this program, the IRS is offering more than 4,000 taxpayers a chance to settle on 21 potentially abusive transactions. The transactions cover a wide variety of tax shelters including shelters involving funds used for employee benefits. Included among the potentially abusive transactions are:

Specially designed life insurance policies in retirement plans,
Abusive Roth individual retirement account transactions,
Welfare benefit funds under IRC § 419A(f)(5),
Employee stock ownership plans holding stock in S corporations,
Abusive reimbursements for employee parking, and
Abusive reimbursements for employees’ medical expenses.

Taxpayers have until January 23, 2006, to submit their settlement information to the IRS. All settling taxpayers will pay 100 percent of taxes owed, interest, and depending on the transaction, either a quarter or a half of the penalty the IRS would otherwise seek. Commissioner of Internal Revenue Mark Everson dismissed possible concerns that the new initiative is too lenient. IRS Announcement 2005-80.

IRS Updates Rules Governing Reimbursements for Food and Lodging Expenses. On October 3, 2005, the IRS issued Revenue Procedure 2005-67. This guidance updates optional rules for using per diems to substantiate employee travel expenses. Under this revenue procedure, the amount of ordinary and necessary business expenses of an employee for lodging, meal, and incidental expenses incurred while traveling away from home will be deemed substantiated when an employer provides a per diem allowance under a reimbursement or other expense allowance agreement.

If a business pays a per diem instead of reimbursing actual lodging, meal, and incidental expenses, the substantiated cost will be determined to be the lesser of the per diem allowance for that day, or the amount computed at the federal per diem rate for the locality of that day’s travel.

Revenue Procedure 2005-67 also provides an optional method for calculating deductible expenses for self-employed individuals and employees who pay or incur business, meal, and incidental expenses while traveling away from home. The methods described in the revenue procedure are not mandatory; the taxpayer may instead use actual allowable expenses as long as there is adequate substantiation.

CASES

Collective Bargaining Agreement Obligates Employer to Make Health and Pension Multiemployer Fund Contributions on Behalf of Non-Union Employees. As River Trucking and Rigging, Inc. (River Trucking) recently found out, the terms of collective bargaining agreements requiring contributions on behalf of employees to union welfare funds need to be carefully drafted to avoid unintended contribution obligations. River Trucking entered into the National Master Freight Agreement (the agreement) with Truck Drivers Local Union No. 807 of the International Brotherhood of Teamsters (the union). Under the terms of the agreement, River Trucking was required to make contributions to the Local 807 Labor-Management Health and Pension Funds (the funds) for each hour worked by employees covered by the agreement. The agreement, for contribution purposes, defined employees by job classification and did not make a distinction between union and non-union employees. The funds hired an auditor to conduct an audit of River Trucking’s payroll, and the auditor determined River Trucking did not make required contributions to the funds for certain non-union employees. The funds sued River Trucking to collect the unpaid contributions. The federal district court that heard the case granted summary judgment in favor of the funds, ruling that the agreement unambiguously required River Trucking to make contributions on behalf of the non-union employees. (Trustees of the Local 807 Labor-Management Health & Pension Funds v. River Trucking and Rigging Inc., E.D.N.Y 2005).

This newsletter is a periodic publication of Hodgson Russ LLP. Its contents are intended for general informational purposes only and should not be construed as legal advice or legal opinion on any specific facts or circumstances. Information contained in the newsletter may be inappropriate to your particular facts or situation. Please consult an attorney for specific advice applicable to your situation. Hodgson Russ is not responsible for inadvertent errors in this publication.