Guidance Issued on Definition of Dependents Under Accident and Health Plan. In Notice 2004-79, the Internal Revenue Service (IRS) provided guidance regarding the new definition of “dependent” put into effect under the Working Families Tax Relief Act of 2004 (WFTRA). As noted in our November 2004 Employee Benefits Developments, WFTRA made changes to the definition of dependent for taxable years beginning after 2004. In addition to modifying and limiting the definition of dependent under Internal Revenue Code of 1986 (IRC) § 152, WFTRA made several amendments to IRC § 105(b) which excludes from an employee’s gross income employer-provided medical care reimbursement paid to the employee or for the employee’s spouse and dependents. Notice 2004-79 clarifies that it was the intent of Congress to make the changes to § 105(b) to maintain the current law definition of dependent for purposes of employer-provided medical care reimbursements. The notice also indicates the IRS will revise the regulations to provide that the term “dependent,” for purposes of IRC § 106, will be the same as for § 105(b). IRC § 106 provides an exclusion for income for employer-provided health care coverage.

New Code for NQDC Reporting on 2005 Form W-2. IRC § 409A, which was added under the American Jobs Creation Act of 2004, requires employers to report annual deferrals under a nonqualified deferred compensation plan on each employee’s Form W-2. Beginning in 2005, the deferred amounts must be reported in box 12 of Form W-2, using Code Y. (IRS Announcement 2004-96)

2005 Mileage Rate. The standard business mileage rate for 2005 is 40.5 cents per mile, up from 37.5 cents per mile in 2004. The standard charitable mileage rate for 2005 is 14 cents per mile and the standard medical and moving mileage rate for 2005 is 15 cents per mile. (Rev. Proc. 2004-64)

IRS Proposes New Comprehensive Regulations for § 403(b) Annuities. Similar to the IRS’s recent regulations for IRC § 401(k) plans and § 457(b) plans for state and local governments, the IRS issued proposed regulations governing a third type of elective deferral plans, § 403(b) annuities. It has been 40 years since the IRS issued comprehensive regulations in this area and numerous tax law changes have been made in the intervening years. Recent tax law changes have made 403(b) annuities similar to 401(k) and 457(b) state and local government plans. The proposed regulations reflect the increasing similarity of these arrangements. A few highlights of the proposed regulations are:

Plan Document Requirement. Existing regulations do not require that a 403(b) annuity be spelled out in a written plan document. The proposed regulations would require that the terms of a 403(b) arrangement be set forth in a plan document containing all material provisions.
Nondiscrimination Requirements. Since the Tax Reform of 1986, 403(b) arrangements have been able to adopt the good faith reasonable standards contained in Notice 89-23 to satisfy the applicable nondiscrimination requirements. The proposed regulations would eliminate the good faith reasonable standards and adopt stricter rules similar to these for qualified retirement plans.
Retirement Income Accounts. These accounts of church-related organizations would be treated as 403(b) annuity contracts. However, the proposed regulations would continue to apply special rules applicable to these arrangements.
Aggregation. New rules for aggregation of certain tax exempt entities for employee benefit purposes would take effect.

These proposed regulations would not go into effect until years after 2005 and cannot be relied upon before they are adopted as final regulations. (69 Fed. Reg. 67,075 (Nov. 16, 2004))

Proposed Pension Plan Phased Retirement Distributions. Proposed regulations issued by the IRS would allow a pension plan under a bona fide phased retirement program to permit employees to phase in their retirement by working fewer hours, and to receive a portion of their pension benefits while still employed. A bona fide phased retirement program would be a written, employer-adopted program under which employees could voluntarily reduce by at least 20% the number of hours they customarily work beginning on or after a retirement date specified in the program (but not before attaining age 59 ½) and receive retirement benefits.

The proposed regulations would permit a pro rata share of an employee’s accrued benefit to be paid before the employee reaches normal retirement age. The pro rata share would be based on the employee’s reduced working hours, which should not exceed 80 percent of their normal, full-time work schedule. Under this pro rata approach, an employee maintains a dual status (partially retired and partially in service) during the phased retirement period. The proposed regulations do not permit payment to be made in the form of a single-sum distribution (or other eligible rollover distribution) to prevent the premature distribution of retirement benefits. The phased retirement benefit will be an optional form of benefit protected by IRC § 411(d)(6) and the election of a phased retirement benefit is subject to the provisions of IRC § 417, including the required explanation of the joint and survivor annuity. The proposed regulations also require that phased retirement benefits may not be paid before an employee reaches age 59 ½, which is consistent with IRC §§ 401(k) and 72(t)(3)(B). The proposed regulations require full-time compensation to be imputed, with a proportionate reduction based on an employee’s actual service, to ensure a participant is not disadvantaged by choosing phased retirement. Subject to exceptions, periodic testing is required under the proposed regulations to ensure that employees in phased retirement are in fact working at the reduced schedule, as expected.

The proposed regulations would apply to only defined benefit and money purchase pension plans, and would be effective for plan years beginning on or after the date the proposed regulations are finalized. These proposed regulations cannot be relied upon before they are adopted as final regulations. (69 Fed. Reg. 65,108 (Nov. 10, 2004))

CASES

Guidance on Determination of Partial Termination of Plan? In Matz v. Household International Tax Reduction Investment Plan, the U.S. Court of Appeals for the Seventh Circuit reexamined the rules for determining whether a partial termination of the plan occurred. At issue is a long existing IRC rule that requires full vesting of participants who lose employment in a “partial termination” of a plan. While this rule has existed for many years, the rules for determining whether a partial termination occurs has been the subject of various interpretations. In this opinion, the federal appellate court reviewed many prior IRS rulings and court decisions, and provides a useful tabulation of these results. The IRS has advocated in formal guidance that if at least 20% of participants lose coverage, a partial termination has occurred. The Seventh Circuit agrees that a 20% reduction creates a rebuttable presumption and finds that if the reduction is below 10% it should conclusively be presumed not to be a partial termination. If the reduction is above 40% it should conclusively be presumed to be a partial termination. Between 10% and 40%, the determination would be made on relevant facts and circumstances relating to the tax motives and tax consequences involved in the reduction in plan coverage. The Seventh Circuit also holds that in determining the percentage of reduction, the numerator and denominator are based on all plan participants and not based solely on those who are not yet vested. While the Seventh Circuit guidelines may not be accepted in other circuits, or ultimately by the U.S. Supreme Court, it provides a method of analysis that should be helpful in determining whether a partial termination has occurred. (Matz v. Household International Tax Reduction Investment Plan, 7th Cir. 2004)

Fiduciary Duty Does Not Apply to Decision Whether to Terminate. Chevron Corp. amended its retirement plan in 1999 to provide enhanced benefits for employees who were involuntarily terminated as part of a planned reduction in force program. Certain employees who were eligible to receive enhanced retirement benefits if they were involuntarily terminated sued Chevron alleging that the company violated its fiduciary duty in deciding not to involuntarily terminate their employment. The U.S. District Court for the Southern District of Mississippi held Chevron Corp. did not breach its fiduciary duties when it chose not to terminate the employees because Chevron was “free to exercise its discretion in making employment decisions related to its proposed reduction in force.” The federal district court held Chevron’s decision whether to discharge employees was a decision made in its capacity as an employer, not as an ERISA plan administrator. (Ferrer v. Chevron Corp., S.D. Miss. 2004)

This newsletter is a periodic publication of Hodgson Russ LLP and should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your own situation and any specific legal questions you may have.