Employee Benefits Law Report

IRS issues 409A guidance—need to correct before the year of vesting

The Office of Chief Counsel of the Internal Revenue Service (the “IRS”) recently confirmed that violations of Section 409A of the Internal Revenue Code (the “Code”) could be corrected without penalty in any taxable year before the taxable year in which an arrangement became vested. However, the IRS went on to clarify that the Code would require immediate recognition of taxable income of the amounts deferred and the assessment of an additional 20% tax if taxpayers waited until the taxable year of vesting to correct an error.

In Chief Counsel Advice 201518013 (the “CCA”),the IRS clarified what some perceived to be an ambiguity under previously issued proposed regulations describing Code Section 409A income inclusion issues. The proposed regulations explained that an employer generally could correct a Code Section 409A error before the arrangement vests without immediate income tax and additional taxes being imposed on the participant. Most practitioners agreed that an arrangement could be corrected without the risk of penalty so long as the compensation under the arrangement became vested no earlier than the taxable year after the taxable year of correction, and the IRS has confirmed that view in the CCA. What was less clear was whether a correction could be made without the risk of penalty if compensation became vested after the date of correction but still within the same taxable year in which the correction was made. In the CCA, the IRS explained that the correction technique works only when the compensation remains unvested throughout the entire taxable year in which the correction is made and vests no earlier than the taxable year after the taxable year of that correction.

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Supreme Court says give credit where credit is due

In Comptroller of Treasury of Maryland v. Wynne, 135 U.S. 1787 (2015), the Supreme Court held that Maryland’s tax scheme was unconstitutional because it discouraged interstate commerce in violation of the Dormant Commerce Clause of the U.S. Constitution. Maryland’s tax scheme gave taxpayers credit for taxes paid to other states against the Maryland state income tax, but did not provide a credit against the county income tax. Therefore, out-of-state income was subject to double taxation, a tax burden not imposed on in-state income.

The Dormant Commerce Clause only gives Congress the ability to regulate interstate commerce, not intrastate commerce. However, shouldn’t activity prohibited at the state level also be prohibited at the municipal level? In Ohio, municipalities are given authority to impose taxes on personal income of both residents and non-residents. In effect, personal income made by an Ohio resident living in one municipality and working in another is taxed twice. In wake of Wynne, Ohio residents should look to a number of Constitutional and fairness arguments to consider whether Ohio’s municipal tax scheme could also be unconstitutional.

Read our full client alert.

Protection of ERISA’s statute of limitations is narrowed by the Supreme Court

The United States Supreme Court yesterday issued a unanimous opinion in Tibble et al. v. Edison International et al. vacating a Ninth Circuit Court of Appeals ruling that claims by employees of Edison International against the company over allegedly imprudent 401(k) plan investments were time-barred under applicable ERISA statute of limitation rules. The issue before the Court was whether a fiduciary breach claim can be brought under ERISA based on such an allegedly imprudent retirement investment when that investment initially was selected outside of ERISA’s applicable six-year statute of limitations. Writing for the Court, Justice Stephen Breyer stated that since plan fiduciaries have a continuing duty to monitor plan investments, any claims falling within that duty’s statute of limitations would be valid.

In this case, individual beneficiaries of the Edison International 401(k) Plan filed a lawsuit on behalf of the 401(k) Plan and similarly situated beneficiaries against Edison International and other related parties. The petitioners sought to recover damages for losses suffered by the Plan in addition to other equitable relief based on alleged breaches of the respondents’ fiduciary duties. Specifically, the petitioners argued that the respondents violated their fiduciary duties with regard to mutual funds added to the Plan in 1999 and in 2002. The action was filed by the petitioners in 2007. The underlying fiduciary claim was that the respondents imprudently selected six higher priced retail-class mutual funds as plan investments when materially identical but lower priced institutional-class mutual funds were available. Since ERISA generally requires a breach of fiduciary duty complaint to be brought no more than six years after the date of the last action that constitutes a part of the breach, the lower courts ruled that the petitioners’ complaint with respect the 1999 funds was barred under ERISA’s statute of limitations because those funds were added to the 401(k) Plan more than six years before the complaint was filed (the lower courts concluded that the attendant circumstances had not changed enough to require that review of the selected mutual funds by the respondents). On the other hand, the lowers courts concluded that the respondents’ failed to satisfy their fiduciary obligations with respect to the selection of the three funds in 2002 (and that portion of the lower court opinions may yet prove to be problematic in other similar situations).  While the rulings of the lower courts with respect to the 1999 funds likely cheered plan sponsors temporarily, the Court did not embrace the position of the lower courts and instead vacated the previous rulings and remanded the case back for further examination of the proper application of fiduciary obligations to the facts at hand.

Justice Breyer notes that the District Court in this case allowed the petitioners to argue that the complaint was timely with respect to the funds added in 1999. The petitioners argued that the respondents should have commenced a review and conversion of the higher priced retail-class mutual funds to lower priced institutional-class mutual because the previously selected funds incurred significant changes within the 6-year statute of limitations period. The District Court concluded, and the Court of Appeals later agreed, that the petitioners failed to show that changing circumstances would have required a prudent fiduciary to undertake a review of the funds within the 6-year statute of limitations period.

Breyer began his review by focusing on the language contained in ERISA’s statute of limitations rule. In that regard, he stated that ERISA Section 1113 reads, in relevant part, that “[n]o action may be commenced with respect to a fiduciary’s breach of any responsibility, duty, or obligation” after the earlier of “six years after (A) the date of the last action which constituted a part of the breach or violation, or (B) in the case of an omission the latest date on which the fiduciary could have cured the breach or violation.” Breyer noted that both prongs of the rule require that a breach or violation occurs within the applicable 6-year period. The petitioners contend that the respondents breached the duty of prudence by offering higher priced retail-class mutual funds when the same investments were available as lower priced institutional-class mutual funds. While in Breyer’s view, the Ninth Circuit Court of Appeals correctly focused on whether the last action that constituted a part of the breach occurred within the relevant 6-year period, he wrote that the lower court inappropriately concluded that only a significant change in circumstances could cause a new breach of a fiduciary duty.

The Court ultimately concluded that the lower courts erred by applying a statute of limitations bar to such a claim of a breach of fiduciary duty without considering the nature of that duty. The opinion states that the lower courts failed to recognize that under applicable trust principles a fiduciary is required to conduct a regular review of plan investments with the nature and timing of the review contingent on the circumstances. Citing a by-now familiar standard, Breyer noted that an ERISA fiduciary must discharge his or her responsibility “with the care, skill, prudence, and diligence” that a prudent person “acting in a like capacity and familiar with such matters” would use. When examining the range of that fiduciary duty, courts often look to the law of trusts. The Court went on to note that under trust law a fiduciary has a continuing duty to monitor plan investments and to remove imprudent ones (this continuing duty is in addition to the trustee’s duty to exercise prudence in selecting investments).  Since under trust law a fiduciary has a continuing duty of some kind to monitor investments and to remove imprudent ones, a petitioner should be permitted to allege that a fiduciary breached the duty of prudence by failing to properly monitor investments. In such a case, Breyer concluded that “so long as the alleged breach of the continuing duty occurred within six years of suit, the claim is timely.”

The Court in this decision expressed no view on the scope of the respondents’ fiduciary duty in this case.[1]  In effect, the case has been remanded so that the Ninth Circuit Court of Appeals can consider claims by the petitioners that the respondents breached their duties within the relevant 6-year statute of limitations period.  Breyer noted that on remand the Court of Appeals may conclude that the respondents did indeed conduct the sort of review that a prudent fiduciary would have conducted absent a significant change in circumstances.  Either way, the Court may well see this case again.

[1] The respondents argued that the petitioners failed to raise in the lower courts a claim that the respondents committed new fiduciary breaches due to a failure to monitor their investments. Given its decision to remand the case back to the Ninth Circuit Court of Appeals, the Court opted to let the Ninth Circuit resolve this ancillary issue.



Public companies should review stock option plans to ensure they qualify for exception to $1 million deduction limit

The IRS and Treasury Department recently issued final regulations under Code Section 162(m) that, as the IRS describes it, “clarifies” stock and equity-based compensation plan drafting issues. Of course, whether something represents a clarification or a substantive change lies in the eye of the beholder (particularly if that beholder is a politician or regulator in need of political cover). In this case, however, the IRS generally is correct to describe the final regulations as clarifications. With respect to stock options and SARs, the new regulations reflect what were widely held opinions in the executive compensation community. With respect to restricted stock units (“RSUs”) and phantom stock granted by privately held companies that become publicly traded, the new regulations could be considered a more substantive change, but the IRS in effect has provided nearly four years’ worth of advanced notice of this change. The good news is that the new regulations should not affect most employers’ stock plans. Still, it would be wise for public companies to perform a review of these plans to confirm whether they qualify for the performance-based exception to the $1 million deduction limit under Code Section 162(m).

Code Section 162(m), generally

As background, Code Section 162(m) limits the deduction that a publicly traded company can take with respect to remuneration paid to its “covered employees”—its CEO and three most highly paid named executive officers (other than the CEO and CFO)—to the extent that such compensation exceeds $1 million. The deduction limit does not apply, however, to qualified performance-based compensation. Publicly traded companies often structure their equity based compensation plans in a manner to qualify the awards under those plans (options, SARs, RSUs, restricted stock, etc.) as performance-based compensation.

Options and SARs

In 2011, the IRS issued proposed regulations that “clarified” that the plan under which options and SARs were granted must specify the maximum number of shares relating to those awards that may be granted to any individual during a specified period. Most practitioners had long counseled their public company clients to put these individual limits in their plans to make sure these awards qualified as performance-based compensation under Code Section 162(m). Some commentators, however, argued that stating an aggregate share limit for all awards should be enough. The IRS rejected this view in the proposed regulations, stating that a per employee limit was necessary to assist a third party in determining the maximum amount of compensation that could be payable to any individual employee during a specified period.

The final regulations formally adopt this view. The one modification is that a plan may specify a maximum number of shares with respect to all types of awards (options, SARs, RSUs, restricted stock, performance shares) that may be granted to an employee during a specified period.

RSUs and phantom stock of private companies that become public

Additionally, the proposed regulations clarified that an existing limited transition period does not apply to grants of RSUs or phantom stock by a company that, at the time the grants are made, is not a publicly traded company in the event that the company later becomes a publicly traded company when the grants are still outstanding. This interpretation reversed a position taken by the IRS in previously issued private letter rulings. The transition period rule generally provides that compensation related to the exercise of stock options or SARs, or the substantial vesting of restricted stock, under a pre-existing plan will not be subject to the $1 million deduction limit for a limited grace period after the company becomes publicly traded. Many practitioners believed that this grace period would apply to phantom stock and RSUs as well, but the proposed regulations said that would not be the case. The final regulations adopt the interpretation of the proposed regulations. Commenters had requested that the relief extend to RSUs and phantom stock, but the IRS did not adopt these recommendations.

Effective dates

The per employee share limits portion of the proposed regulations were effective with respect to options and SARs granted on or after June 24, 2011. The final regulations state that this rule remains effective as of that date. The preamble explains that a transition period for that rule is not necessary because this interpretation did not represent a substantive change in the rules. On the other hand, the interpretation regarding RSUs and phantom stock awarded previously by privately held companies that become public companies will become effective on the date the final regulations are published in the Federal Register.

Again, because the final regulations confirm what the IRS has long been telling us about equity-based compensation awards, most publicly traded companies probably will not see much, if any, impact on their plans. Nevertheless, the publication of the final regulations represents a good opportunity to review these companies to make sure that the awards under their plans still qualify for the performance-based compensation exception to the $1 million deduction limit.

Ninth Circuit decision illustrates importance of clearly designating beneficiaries under a nonqualified plan

In a recent blog, we discussed the importance of clearly defining who is a “participant” in a nonqualified plan and who is a former participant or retiree. A more recent Ninth Circuit decision in E & J Gallo Winery v. Rogers highlights a related issue that faces tax-qualified and nonqualified plans alike—who is the beneficiary? While cases like this may not raise novel issues of law, they highlight a more mundane yet important issue of preparing plan documents clearly and in a manner that is consistent with their administration. Further, the Gallo decision highlights the importance of reminding plan participants to make sure that they have completed beneficiary designation forms and that those forms are up-to-date.

In the case, E & J Gallo Winery filed an interpleader action to determine the proper beneficiary under its Key Executive Profit Sharing Retirement Plan, a nonqualified deferred compensation plan (the “Plan”). Robert Rogers had accrued a benefit under the Plan before he died.  After his death, ambiguity arose as to who was Robert’s designated beneficiary entitled to receive his accrued benefit under the Plan. Michele McKenzie-Rogers, who was married to the deceased at the time of his death, had filed a motion for summary judgment arguing that she was the proper beneficiary under the Plan. The District Court denied this motion and instead held that Mark Rogers, Robert’s son from a prior marriage, was the proper beneficiary. McKenzie-Rogers appealed that decision, and upon hearing that appeal the Ninth Circuit affirmed the District Court’s decision.

The ambiguity arose over a letter that was sent by the Plan sponsor to Robert Rogers in 1988. The third paragraph of that letter explained to him that vesting, payment methods and “all other matters” under the Plan would be determined in accordance with the procedures set forth under Gallo’s tax-qualified plan document. According to McKenzie-Rogers, the “all other matters” language meant that the tax-qualified plan’s beneficiary rules, which paid benefits to the current surviving spouse, should apply to the nonqualified Plan as well. The District Court disagreed, holding that this interpretation was too broad, especially because the fourth paragraph in that letter clearly named Roger’s first wife as primary beneficiary and his son Mark as contingent beneficiary. However, Rogers’ first wife waived her rights as primary beneficiary under the Plan by signing a waiver and release in 1988. As a result of that waiver, the District Court concluded the participant’s son Mark became entitled to the benefits under the Plan as contingent beneficiary. Nothing in the Plan indicated that the participant’s subsequent re-marriage to McKenzie-Rogers canceled his prior beneficiary designations. Moreover, the Plan was exempt from ERISA’s spousal consent requirements (which, if applicable, automatically would have made McKenzie-Rogers the beneficiary when she married Rogers). The Ninth Circuit agreed with this analysis and affirmed the District Court’s decision.

Again, this decision provides two takeaway items for plan sponsors. One is to make sure that the plan document and communications with the participants clearly explain how participants may designate beneficiaries. The other is that plan sponsors should consider periodically sending reminders to participants to make sure that their beneficiary designation forms are up-to-date. Clear documentation and communication can help reduce ambiguity and help sponsors avoid this type of lawsuits in the future.

ERISA damages—two bites off the same apple are impermissible

The United States Court of Appeals for the Sixth Circuit issued an en banc decision in Rochow v. Life Insurance Company of North America on March 5, 2015 that deals with the ability of a participant in a plan covered by ERISA to recover benefits due from that plan while simultaneously pursuing “other appropriate equitable relief” based on that same asserted injury. In a decision likely to be applauded by many plan sponsors, the court’s en banc decision concluded that both forms of recovery are inappropriate when based on the same injury except in limited circumstances—circumstances that were not satisfied in this case.

The facts of the case involve a claim for long term disability benefits filed by Daniel Rochow under a policy issued by Life Insurance Company of North America (“LINA”). After LINA denied that claim and all administrative appeals also were unsuccessful, Rochow filed an action in the United States District Court for the Eastern District of Michigan. That complaint sought to recover benefits due to Rochow under the applicable disability policy under ERISA Section 502(a)(1)(B) and to seek appropriate equitable relief to redress an alleged fiduciary breach under ERISA Section 502(a)(3). Continue Reading

Supreme Court revisits Obamacare

Veteran observers of the United States Supreme Court regularly and wisely advise not to make too much out of the questions asked by the justices during oral argument as a predictor of ultimate outcome.  Having said that, the first reaction of those who follow these oral arguments (often including some of those veteran observers) invariably is an attempt to weigh the likely judicial mindsets of the justices by the questions asked at oral argument (other than for Justice Clarence Thomas, who traditionally does not ask questions at oral arguments).  Why should today be any different?

The Court heard oral argument on Wednesday, March 4 in King v. Burwell, a case that goes to the core functionality of the Affordable Care Act (the “ACA”) by raising the issue whether four words in the body of the ACA (for the curious, those four words as “established by the State”) mean that subsidies payable by the federal government to defray the cost of health care coverage are only available to residents in states that have established their own health care exchanges.  The plaintiffs in the King v. Burwell case argue that subsidies should not be available to residents in states that have not adopted health care exchanges.  Under the ACA, states are not required to establish their own health care exchanges.  If a state chooses not to do so, the federal government is required to assume that responsibility.  Currently, 37 states have opted not to create their own state exchanges (thus relegating residents in those states to the federally-run health care exchange).  While this case does not deal with weighty issues of constitutional law, the stakes nonetheless are huge.  Most studies indicate that millions of Americans who currently have health care coverage (some studies peg that number as high as 9 million people) would lose that coverage if they lost entitlement to the subsidies because they could not afford to pay for coverage on their own.  The resulting loss of such a large number of customers would be expected to cause great havoc in the insurance market. Continue Reading

Expanding the definition of fiduciary under ERISA—déjà vu all over again

The United States Department of Labor (the “DOL”) submitted to the Office of Management and Budget (the “OMB”) a revised version of the “conflict of interest” rule expanding the definition of the term “fiduciary” on Monday, February 23, 2015.  Generally, the OMB has up to 90 days to review rules, although review times can vary considerably.  Subsequent to the OMB review, the proposed rule is published and interested stakeholders are permitted to make comment on the proposed rule.

ERISA imposes certain obligations on persons who act as plan fiduciaries, including the imposition of liability for losses attributable to a failure to meet applicable fiduciary standards.  In that regard, under this standard fiduciary obligations may be imposed on investment advisors that provide investment advice to a plan in return for a fee or other compensation, whether payable directly or indirectly.  The DOL has become concerned over the last several years that the breadth of the current rule is both outdated and inadequate, and that it fails to reach certain investment professionals who provide investment services to plans and individuals with respect to retirement assets (including individual retirement accounts).

The DOL first attempted to revise this fiduciary standard back in 2010 with the publication of a proposal that many observers concluded would have expanded the breadth of the rule with respect to investment professionals.  That proposal ran into considerable headwind, and drew wide-ranging criticism both from the business community (including Wall Street) and from Congress.  Eventually that proposal was withdrawn, perhaps influenced by political considerations as the 2012 presidential campaign drew near.

Like in 2010, this new proposal presumably will aim at expanding the application of fiduciary burdens on persons that provide investment advice.  While the actual language of the new proposal is not scheduled to become public until it is published following OMB’s review, it seems likely to inspire the same wave of opposition that arose in 2010 (even though the political calculations might be different this time around).  As an indication of how political considerations at the White House may have evolved, President Obama took the somewhat unusual step of announcing the filing of the re-proposed rule at the OMB on February 23.  That speech followed closely behind a conference call on February 22 covering the benefits of the re-proposed rule that featured DOL Secretary Tom Perez.  To complete this “full court press,” the White House released both a fact sheet touting the proposed rule and a report from the Council of Economic Advisors that reviews the negative implications of conflicted investment advice.  Many observers thought the White House walked away from these proposals a few years ago in the face of considerable business and political pressure.  Such a tactical retreat seems less likely this time around, at least at the present time, and thus this initiative bears watching.

Who is “participant” in a nonqualified plan? Second Circuit case highlights importance of defined terms

One issue that sometimes arises when drafting a nonqualified plan document (or qualified plan for that matter) is how to define a “participant” in the plan. Typically, a plan will define “participant” broadly to include anyone who has an account balance or an accrued benefit under the plan and who has yet to be paid his or her complete benefit. This broad definition includes both active employees who generally are accruing additional benefits as well as former employees who no longer are accruing benefits but still are entitled to payments under the plan. Sometimes, however, an employer may not think in broad terms and instead want to use the term “participant” interchangeably with “employee.” Although courts typically show a certain measure of deference to employers in how they interpret their plans, a recent Second Circuit decision (Gill v. Bausch & Lomb, 14-1058, 2d Cir. 2014) reminds us that plan administrators should not get too carried away with relying on administrative discretion and should be mindful of the specific terms they use to define a participant.

Case Background

Bausch & Lomb (the “Company”) maintained a nonqualified deferred compensation plan (the “Plan”) that covered three retired executives. The Plan contained a change of control provision, pursuant to which a “participant’s” benefit would be converted to a cash lump-sum and paid within 15 days following a change in control of the Company. The applicable provision expressly referred only to “participants.” This latter point proved to be important because the Plan contained definitions of both “participants” and “retired participants.” In May 2007, a private equity firm acquired all of the outstanding shares of the Company, which triggered the change in control payments under the Plan. After the change in control, the Company’s Compensation Committee instructed the Plan’s trustee not only to provide lump sum payments to active participants but also to discontinue installment and annuity payments to the “retired participants” and instead pay them any remaining benefits in a lump sum as well.

The retired participants cried foul, in part because they alleged that the lump sum payments had actuarial values that were less than the actuarial equivalent of their remaining monthly benefits. They brought suit, alleging that the termination of the monthly benefits and the payment of the reduced lump-sum violated ERISA. The district court held that the Plan prohibited the cancellation of monthly benefits for retirees. The court allowed the retirees to retain the lump-sum payments they previously received and ordered the reinstatement of the monthly benefits to the retired participants, albeit at a lesser amount to reflect the lump sum payment the participants retained. The Second Circuit affirmed.

Interpretation of the Plan’s Defined Terms

The appeals court’s decision relied on the plain language of the Plan. The Company had tried to argue that retired participants should be viewed as a “subset” of participants, and thus subject to the lump sum cash-out provision upon a change in control.  In fact, many employers often view “participants” as covering both active employees as well as former employees or retirees who have not received full payment under the plan. The court rejected the Company’s argument, however, stating that the Plan clearly defined a “participant” as an active employee and a “retired participant” as a retiree. Even if the Company never intended to distinguish active and former employees in this manner, the court concluded it could not ignore the clear text of the Plan. The plain text clearly defined retirees as not being “participants” under the Plan. Because of that, the Company could not cash out their benefits upon a change in control.


The lesson from the case is a straightforward one. It may be easy to think of “participants” interchangeably with employees, but it is important for employers to remember that until a final payment is made under a plan, former employees have rights under a plan too. Consequently, employers should be mindful of how a plan is designed to treat both active and former employees.

Obama administration budget proposals could affect employee benefit programs

The Obama administration recently released its budget proposals for Fiscal Year 2015 and as in past years those proposals contained a number of provisions that would affect employee benefit plans. A helpful explanation of the administration’s proposals can be found in the Administration’s Fiscal Year 2016 Revenue Proposals (sometimes referred to as the “Green Book”), which was issued by the Department of the Treasury.

A brief explanation of provisions contained in the proposed budget that affect employer benefit plans (directly or indirectly) are as follows:

1.    Revisions to child care tax incentives. Effective for taxable years beginning after December 31, 2015, this proposal would increase the child and dependent care credit, and create a larger credit for taxpayers with children under age five. Related to these changes, the proposal would repeal dependent care flexible spending accounts and thus require changes to many employer-sponsored cafeteria plans.

2.    Revisions to Tax Credit to Qualified Small Employers for Non-Elective Contributions to Health Insurance. The Affordable Care Act created a tax credit to help small employers provide health insurance for employees and their families. Without going into the mechanics of that credit, the proposal would expand the group of employers eligible for the credit to include employers with up to 50 full-time equivalent employees and would begin the phase-out of the credit at 20 full-time equivalent employees. In addition, the proposal would change the coordination of the phase-outs based on average wage and the number of employees so as to provide a more gradual combined phase-out. The proposal also would eliminate the requirement that an employer make a uniform contribution on behalf of each employee (although nondiscrimination laws still will apply). These proposals would be effective for taxable years beginning after December 31, 2014.

3.    Automatic Enrollment in IRA’s (Including Small Employer Tax Credit), Increase Tax Credit for Small Employer Plan Start-Up Costs, and Provide Additional Tax Credit for Small Employer Plans Newly Offering Auto-Enrollment. The proposal would require employers in business for at least two years that have more than ten employees but do not sponsor a qualified retirement plan, SEP, or SIMPLE for their employees to offer an automatic IRA option to those employees, under which regular contributions would be made to an IRA on a payroll-deduction basis. However, if the qualified plan excluded from eligibility a portion of the employer’s work force or a class of employees such as all employees of a subsidiary or division, then the employer would be required to offer the automatic IRA option to those excluded employees. An opt-out feature would be available to employees. Employees could choose either a traditional IRA or a Roth IRA, with Roth being the default.

Contributions by employees to automatic IRAs would qualify for the saver’s credit to the extent the contributor and the contributions otherwise qualified. Small employers (those that have no more than 100 employees) that offer an automatic IRA arrangement could claim a temporary non-refundable tax credit up to $1,000 per year for three years, and they would be entitled to an additional non-refundable credit of $25 per enrolled employee up to $250 per year for six years.

To encourage employers not currently sponsoring a qualified retirement plan, SEP, or SIMPLE to do so, the non-refundable “start-up costs” tax credit for a small employer that adopts a new qualified retirement plan, SEP, or SIMPLE would be tripled from the current maximum of $500 per year for three years to a maximum of $1,500 per year for three years and extended to four years (rather than three) for any employer that adopts a new qualified retirement plan, SEP, or SIMPLE during the three years beginning when it first offers (or first is required to offer) an automatic IRA arrangement. Finally, small employers would be allowed a credit of $500 per year for up to three years for new plans that include auto enrollment (which would be in addition to the “start-up costs” credit referenced just above). Small employers also would be allowed a credit of $500 per year for up to three years if they added auto enrollment as a feature to an existing plan.

These proposals would become effective after December 31, 2016.

4.    Expand Penalty-Free Withdrawals for Long-Term Unemployed. This proposal would expand the exception from the 10-percent additional tax to cover certain distributions to long-term unemployed individuals from IRAs and from 401(k) or other tax-qualified defined contribution plans. An individual would be eligible for this expanded exception with respect to distributions if (1) the individual has been unemployed for more than 26 weeks by reason of a separation from employment and has received unemployment compensation for that period (or, if less, for the maximum period for which unemployment compensation is available to the individual), (2) the distribution is made during the taxable year in which the unemployment compensation is paid or in the succeeding taxable year, and (3) the aggregate of all such distributions does not exceed the annual limits described below.

To be eligible for the exception, the aggregate of all such distributions received by an eligible individual from IRAs with respect to the separation from employment generally may not exceed half of the aggregate fair market value of the individual’s IRA and the aggregate of all such distributions received by the eligible individual from 401(k) or other tax-qualified defined contributions plans with respect to the separation from employment may not exceed half of the aggregate fair market value of the individual’s non-forfeitable accrued benefits under those plans as of the date of the first distribution. A special rule exempts the first $10,000 of otherwise eligible distributions (even if that is greater than half of the aggregate fair market value of the individual’s IRAs or non-forfeitable defined contribution plan benefits). Eligible distributions with respect to any separation from employment would be limited to a maximum of $50,000 per year during each of the two years when distributions would be permitted under this exception (for a total of $100,000 with respect to any single period of long-term unemployment).

This proposal would apply to eligible distributions occurring after December 31, 2015.

5.     Require Retirement Plans to Allow Long-Term Part-Time Workers to Participate. This proposal would require 401(k) plans to make employees who have worked at least 500 hours per year for at least three consecutive years eligible to make salary reduction contributions. This proposal would not apply to the eligibility to receive employer contributions, including employer matching contributions. The proposal also would require a plan to credit, for each year in which such an employee worked at least 500 hours, a year of service for purposes of vesting in any employer contributions. With respect to employees newly covered under the proposed change, employers would receive nondiscrimination testing relief, including permission to exclude these employees from top-heavy vesting and top-heavy benefit requirements. This proposal would apply to plan years beginning after December 31, 2015.

6.     Facilitate Annuity Portability. A section 401(k) plan generally cannot distribute amounts attributable to an employee’s elective contributions before (a) the employee’s death, disability, severance from employment, attainment of age 59½, or hardship or (b) termination of the plan. In addition, and subject to certain exceptions, distributions from a qualified retirement plan are subject to a 10-percent withdrawal penalty. The proposal would permit a plan to allow participants to take a distribution of a lifetime income investment through a direct rollover to an IRA or other retirement plan if the annuity investment no longer can be held under the plan, without regard to whether another event permitting a distribution has occurred. Any such distribution would not be subject to the 10-percent withdrawal penalty. This proposal would be effective for plan years beginning after December 31, 2015.

7.     Simplify Minimum Required Distributions Rules. The proposal would exempt an individual from the minimum required distribution rules if the aggregate value of the individual’s IRA and tax-favored retirement plan accumulations does not exceed $100,000 (indexed for inflation after 2016). For this purpose, benefits under qualified defined benefit pension plans that have already begun to be paid in life annuity form would be excluded in determining the dollar amount of the accumulations. The minimum required distribution rules would phase in ratably for individuals with aggregate retirement benefits between $100,000 and $110,000. This proposal would be effective for taxpayers attaining age 70½ on or after December 31, 2015 and for taxpayers who die on or after December 31, 2015 before attaining age 70½.

8.     Allow All Inherited Plan and IRA Balances to be Rolled over Within 60 Days. The proposal would expand the options available to a surviving non-spouse beneficiary under a tax-favored employer retirement plan or IRA for moving inherited plan or IRA assets to a non-spousal inherited IRA by allowing 60-day rollovers of such assets. This treatment would be available only if the beneficiary informs the new IRA provider that the IRA is being established as an inherited IRA. This proposal would be effective for distributions made after December 31, 2015.

9.     Require Non-Spouse Beneficiaries of Deceased IRA Owners and Retirement Plan Participants to Take Inherited Distributions Over No More than Five Years. Under the proposal, non-spouse beneficiaries with respect to retirement plans and IRAs generally would be required to take distributions over no more than five years. Exceptions would be provided for certain eligible beneficiaries, for whom distributions would be allowed over the life or life expectancy of the beneficiary beginning in the year following the year of the death of the participant or owner. Special rules would apply to distributions to children who have not reached the age of majority. Any balance remaining after the death of a beneficiary (including any beneficiary excepted from the five-year rule or a spouse beneficiary) would be required to be distributed by the end of the calendar year that includes the fifth anniversary of the beneficiary’s death. The proposal would be effective for distributions with respect to plan participants or IRA owners who die after December 31, 2015. The requirement that any balance remaining after the death of a beneficiary be distributed by the end of the calendar year that includes the fifth anniversary of the beneficiary’s death would apply to participants or IRA owners who die before January 1, 2015, but only if the beneficiary dies after December 31, 2015.

10.     Limit the Total Accrual of Tax-Favored Retirement Benefits. The proposal would prohibit any taxpayer who has accumulated amounts within the tax-favored retirement system (including IRAs, section 401(a) plans, section 403(b) plans, and funded section 457(b) arrangements maintained by governmental entities) in excess of the amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan under current law (currently $210,000) generally would be prohibited from making additional contributions or receiving additional accruals under any of those arrangements. Plan sponsors and IRA trustees would be obligated to report each participant’s account balance as of the end of the year as well as the amount of any contribution to that account for the plan year. If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings and gains. The proposal would be effective with respect to contributions and accruals for taxable years beginning after December 31, 2015.

11.     Limit Roth Conversions to Pre-tax Dollars. The proposal would permit amounts held in a traditional IRA to be converted to a Roth IRA (or rolled over from a traditional IRA to a Roth IRA) only to the extent a distribution of those amounts would be includable in income if they were not so rolled over. Accordingly, after-tax amounts held in a traditional IRA could not be converted to Roth amounts. A similar rule would apply to eligible retirement plans. This proposal would apply to distributions occurring after December 31, 2015.

12.     Eliminate Deduction for Dividends on Stock of Publicly-Traded Corporations Held in Employee Stock Ownership Plans. The proposal would repeal the deduction currently available for dividends paid with respect to employer stock held by an ESOP sponsored by a publicly traded corporation. Rules allowing for immediate payment of an applicable dividend and permitting the use of an applicable dividend to repay loans used to purchase the stock of the publicly traded corporation would continue to apply. This proposal would apply to dividends and distributions that are paid after the date of enactment.

13.     Repeal Exclusion of Net Unrealized Appreciation in Employer Securities. The proposal would repeal the exclusion of net unrealized appreciation in employer stock for participants in tax-qualified retirement plans who have not yet attained age 50 as of December 31, 2015. Participants who have attained age 50 on or before December 31, 2015 would not be affected by the proposal. The proposal would apply to distributions made after December 31, 2015.

14.     Require Form W-2 Reporting for Employer Contributions to Defined Contribution Plans. The proposal would require employers to report the amounts contributed to an employee’s accounts under a defined contribution plan on the employee’s Form W-2. This proposal would be effective for information returns due for calendar years beginning after December 31, 2015.

15.     Increase Certainty with Respect to Worker Classification. For both tax and nontax purposes, workers must be classified into one of two mutually exclusive categories: employees or independent contractors. Worker classification generally is based on a common-law test for determining whether an employment relationship exists. The main determinant is whether the service recipient has the right to control not only the result of the worker’s services but also the means by which the worker accomplishes that result. These determinations directly affect entitlement to employee benefit plan coverage. Under a special provision (section 530 of the Revenue Act of 1978), a service recipient may treat a worker as an independent contractor for Federal employment tax purposes even though the worker actually may be an employee under the common law rules if the service recipient has a reasonable basis for treating the worker as an independent contractor and certain other requirements are met. If a service recipient meets these requirements, then the IRS is prohibited from reclassifying the workers as employees. The special provision also prohibits the IRS from issuing generally applicable guidance addressing the proper classification of workers.

The proposal would permit the IRS to require prospective reclassification of workers who currently are misclassified and whose reclassification has been prohibited under current law. The Department of the Treasury and the IRS also would be permitted to issue generally applicable guidance on the proper classification of workers under common law standards. For this purpose, Treasury and the IRS would be directed to issue guidance interpreting common law in a neutral manner, and would be expected to develop guidance that would provide safe harbors and/or rebuttable presumptions. Service recipients would be required to give notice to independent contractors, when they first begin performing services for the service recipient, that explains how they will be classified and the consequences thereof, e.g., tax implications, workers’ compensation implications, wage and hour implications. The IRS would be permitted to disclose to the Department of Labor information about service recipients whose workers are reclassified.

This proposal would be effective upon enactment, but prospective reclassification of those covered by the current special provision would not be effective until the first calendar year beginning at least one year after date of enactment. The transition period could be up to two years for workers with existing written contracts establishing their status.

At this point it is difficult to predict whether any of these proposals, many of which are not new, will become law. As in previous years, the Obama administration’s budget proposals were labeled “dead on arrival” by the Republican-controlled Congress (or perhaps even more appropriately “dead even before arrival”). While uncertain, some of these proposals could find their way into a compromise package that ultimately might be negotiated, so some attention is warranted.