United States: Qualified Retirement Plans: May and June 2006 Developments

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA, P. L. 109-222, 5/17/2006), signed by the President on May 17, 2006, includes expanded opportunities for Roth IRA conversions. The primary purposes of TIPRA are to provide alternative minimum tax relief (AMT relief) for individuals for 2006, two more years of low tax rates for capital gains and qualified dividends, and two more years of favorable Code Section 179 expensing deductions for businesses. To offset the revenue losses from these provisions, TIPRA includes provisions for increasing tax revenue, including removing the adjusted gross income ceiling (AGI ceiling) for traditional IRA to Roth IRA conversions after 2009. For tax years commencing after December 31, 2009, the Act eliminates the AGI ceiling for conversions of traditional IRAs to Roth IRAs and permits married taxpayers filing a separate return to convert traditional IRA amounts to Roth IRA accounts.

The current AGI limit for individual IRA owners to be able to make a conversion to a Roth IRA is $100,000 (not including the amount of the conversion or any required minimum distributions for the year). The income resulting from the conversion is included in the tax return for the year of conversion and the 10% premature distribution penalty does not apply.

Qualified distributions from Roth IRAs are not included in taxable income. Qualified distributions are those made after the 5-tax-year period beginning with the first tax year for which the taxpayer made a contribution to a Roth IRA and are made on or after the taxpayer attains age 59 ½; at or after death of the taxpayer if paid to a beneficiary or an estate; on account of disability; or for a first time home purchase under Code Section 72(t).

A wrinkle in TIPRA provides that traditional IRA to Roth IRA conversions in 2010 (only) do not result in taxable income in 2010 unless the IRA owner makes a special election. The regular rule for 2010 conversions only will be that one-half of the resulting income will be taken into income in 2011 and one-half will be taken into income in 2012. The rules are complex and careful planning and good tax counsel will be needed to make proper use of this new planning opportunity.

The recently re-issued Employee Plans Compliance Resolution System (EPCRS, Rev. Proc. 2006-27) permits plan sponsors, for the first time, to use EPCRS to correct participant loan errors and the Department of Labor’s Voluntary Fiduciary Correction Program (VFC Program) provides relief for plan fiduciaries when plan loan problems are corrected under EPCRS. This coordination of correction methods by IRS and DOL offers a meaningful opportunity for plan sponsors to address needed plan loan problem corrections. New Rev. Proc. 2006-27 was noted in the May 2006 EB Newsletter.

ERISA’s anti-alienation provision prevents plans from following the directions of Michigan prison wardens to send pension checks of prisoners directly to their prison addresses (DaimlerChrysler Corp. v. Cox, 6th Cir., No. 05-1716, 5/23/06). The Sixth Circuit ruled that ERISA preempted Michigan’s State Correctional Facility Reimbursement Act (SCFRA), which would have required an "involuntary transfer of benefits into the hands of a state representative without the permission" of plan participants, in violation of ERISA’s anti-alienation provision.

The U. S. Supreme Court unanimously upheld a health plan’s recovery under its subrogation provision as "equitable" relief under ERISA (Sereboff v. Mid Atlantic Medical Services, Inc., U. S. No. 05-260, 5/15/2006). The Court distinguished Sereboff from its 2002 decision in Great-West Life & Annuity Insurance Co. v. Knudson (534 U. S. 204, 2002), in which the Court had held that an ERISA-governed health plan’s claim seeking reimbursement from a plan participant out of a special needs trust was not equitable relief and thus not permitted by ERISA Section 502(a)(3). The Court found that in Sereboff the plan fiduciary sought to recover specifically identifiable funds from the participant (a form of equitable relief), whereas, in Knudson, the plan fiduciary did not make a claim for "specifically identifiable" funds that were in the participant’s possession (i. e., the funds were in a special needs trust established under California law) so the relief claimed in Knudson was "legal," rather than "equitable." The distinction between equitable and legal relief in ERISA cases has been addressed in many cases since Knudson, without much consistency or clarity. Sereboff seems to create a reasonably clear road map for ERISAgoverned health plans to enforce their subrogation claims in the future.

Department of Labor officials have indicated that they are hopeful that the decision in Sereboff will also signal to lower courts that monetary remedies are appropriate as equitable relief for certain serious violations of ERISA by fiduciaries.

IRS Notice 2006-59 (June 20, 2006) provides guidance on certain tax consequences of major disaster leave-sharing plans. A major disaster leave sharing plan must be in writing and must treat payments to recipients of donated leave as wages under FICA, FUTA, and income tax withholding requirements. Donated leave must be used for disaster-related purposes, including off-setting a negative leave balance of the recipient of the donated leave, but cannot be converted into cash that is paid other than as leave compensation at the recipient’s regular rate of pay. The amount of leave donated in a year generally cannot exceed the donating employee’s maximum leave accrual for the year and a donating employee cannot specifically designate the recipient of the donated leave. Donated disaster leave must be allocated only to recipients affected by that specific disaster and, if not used, must be returned proportionately to the donating employees. Donating employees cannot claim an expense, charitable contribution, or loss deduction on account of their deposit of leave into a major disaster leavesharing plan or on account of the use of the deposited leave by recipients.

IRS Chief Counsel Office representative Stephen Tackney reported on possible approaches to certain equity compensation issues that are the subject of the Code Section 409A final rules expected to be issued later this year. He reported that some of the most fluid equity compensation issues under consideration as part of preparation of final regulations include what is service recipient stock, what is a sufficient nexus between the employer and the employee, how to value stock, and how to treat modifications of stock options, including extensions. He did not indicate when the final Code Section 409A regulations are expected to be released. The final regulations will require most existing nonqualified deferred compensation arrangements and many employment contracts to be amended. The delay in publishing the final regulations may also cause the IRS to extend the December 31, 2006, compliance deadline.

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