Guest Article

(From the July 21, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Transfers from a Qualified Plan to a Foreign Trust -- IRS Guidance and Relief

IRS recently ruled that a transfer from a plan qualified under IRC § 401(a) to a nonqualified foreign trust constitutes a taxable distribution. However, the administrator of a plan created in Puerto Rico is permitted to make an election under ERISA § 1022(i)(2) to have Title II apply (i.e., to apply the requirements for minimum participation, vesting, funding, etc.). If such an election is made, the plan is considered qualified and transfers to the plan will not be treated as a distribution even though the trust continues to be classified as a foreign trust. Revenue Ruling 2008-40.

Analysis Summary

Under the first situation presented, an Employer maintained Plan A and Plan B. Plan A was qualified under IRC § 401(a) and covered employees in the U.S. and Country X. Plan B was organized under the laws of Country X, was not qualified under IRC § 401(a), and covered only employees who worked exclusively in Country X. The Plans were amended to provide for the assets and liabilities held in the Plan A trust on behalf of the Country X employees to be transferred to the Plan B trust.

Explaining that "a nonqualified plan can not be a continuation of a qualified plan," IRS ruled that the transfer from a qualified plan to a nonqualified plan constitutes a distribution, and that the distribution will result in disqualification of the transferor plan if the applicable qualification requirements are not satisfied (e.g., if the participant was not eligible for distribution, if the transfer impermissibly eliminated protected rights in violation of IRC § 411(d)(6), etc.).

Under the second situation presented, an Employer maintained Plan C and Plan D. Plan C was qualified under IRC § 401(a), satisfied the Puerto Rican Code § 1165(a) requirements, and covered employees in the U.S. and Puerto Rico. Plan D was a Puerto Rican plan under ERISA § 1022(i)(1), was not qualified under IRC § 401(a), and covered only employees who worked exclusively in Puerto Rico. The Plans were amended to provide for the assets and liabilities held in the Plan C trust on behalf of the employees in Puerto Rico to be transferred to the Plan D trust.

Analyzing the ERISA provisions unique to Puerto Rican plans, IRS explained that under ERISA § 1022(i)(1) any trust forming part of a pension, profit sharing or stock bonus plan in which all the participants are residents of Puerto Rico is generally exempt from taxation for purposes of IRC § 501(a). Such plans are treated as if they are qualified under IRC § 401(a) for this purpose. However, the favorable tax treatment granted to the trust under ERISA § 1022(i)(1) does not extend qualified status under IRC § 401(a) to the plan. Rather, ERISA § 1022(i)(2) separately allows for such putative qualified status by permitting the plan administrator of such a plan organized in Puerto Rico to elect to have the ERISA Title II provisions (which incorporate the IRC qualification requirements) apply to the plan. IRS concluded that since such an election was not made in the situation presented the transfer constituted a distribution.

Transition Relief

In light of the potentially severe negative consequences for qualified plans that previously made transfers to nonqualified foreign trusts, IRS granted some fairly generous transition relief in the Revenue Ruling.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.