Guest Article

(From the July 28, 2003 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits. Hyperlinks within the article have been added by BenefitsLink.)

House Ways and Means Committee Reports Comprehensive Pension Reform Bill with Uncertain Future

The House Ways and Means Committee on July 18 approved a comprehensive pension reform bill by a voice vote, but only after Committee Democrats left the hearing in protest over the amount of time they were given to review the Chairman's substitute. Committee Members Rob Portman (R-OH) and Ben Cardin (D-MD) introduced the bill, H.R. 1776, the "Pension Preservation and Savings Expansion Act," in early April. But there are numerous substantive differences between the 207-page bill they introduced and the 91-page substitute the Committee considered and reported, as discussed below.

The dispute between Ways and Means Committee Democrats and Republicans, which eventually spilled over onto the House floor, was not about the substantive provisions of H.R. 1776 or the Chairman's substitute. Nonetheless, the dispute apparently has slowed the bill's progress.

Ways and Means Committee Chairman Bill Thomas (R-CA) apologized publicly for his role in last week's events, which may help ease tensions. But the House's adjournment on Friday, July 25, for its annual August recess will delay action on the bill until at least September.

30-Year Treasury Rate Replacement

As discussed in last week's Washington Bulletin, the reported bill would temporarily replace the 30-year Treasury rate with a long-term corporate bond rate for purposes of determining minimum funding requirements and lump sum distribution amounts, among other things. The new rate would apply to plan years beginning after December 31, 2003, and before January 1, 2007, for pension funding purposes. Plans would continue using the 30-year Treasury rate for calculating lump sums in 2003, 2004, and 2005. In 2006, plans would use the lower of the corporate bond rate or a modified 30-year Treasury rate to calculate lump sums. Plans would have to resume using the 30-year Treasury rate for funding and lump sum calculations in 2007 unless Congress acted to extend the temporary relief or provide a permanent replacement.

Even if the debate over H.R. 1776 bogs down, there is a chance this provision will move as part of other legislation or as a stand-alone bill. Key members of Congress and Administration officials have identified this as a priority issue. Also, the Joint Committee on Taxation estimates the provision in the reported bill would raise more than $5 billion in revenue over 5 years, and $39 million over 10 years. (The revenue losses attributable to the provision would occur in 2007 and beyond, when the long-term corporate bond rate would not be in effect.) As a result, the temporary 30-year Treasury rate replacement provision could be an attractive addition to any moving tax bill.

Accelerate EGTRRA Limit Increases

The reported bill would accelerate the scheduled increases in the elective deferral and catch-up contribution limits for 401(k), 403(b), 457 and SIMPLE plans, as well as the scheduled increases in the IRA contribution limits. Specifically, section 101 of the bill would--

Also, section 102 would increase the IRA deductible contribution limit to $5,000 and the IRA catch-up contribution limit to $2,500 in 2004.

Unlike the bill Representatives Portman and Cardin introduced, the reported version of H.R. 1776 would not repeal the December 31, 2010, sunset date for EGTRRA's retirement savings provisions. Furthermore, the accelerated limits would be subject to the EGTRRA sunset. This is one of the techniques the Committee used to keep the total cost of the reported bill down. (The estimated 10-year cost of the reported bill is $48 billion, compared to $230 billion for the bill Representatives Portman and Cardin introduced.)

Accelerated Vesting Requirements for Nonelective Employer Contributions to Defined Contribution Plans

The reported bill (§104) would mandate 3-year cliff or 2 to 6 year graded vesting for employer nonelective contributions to defined contribution plans. (These are the same vesting requirements that EGTRRA mandated for employer matching contributions.)

Statutory Stock Options and Employment Taxes

The reported bill (§701) would clarify that exercising an incentive stock option, purchasing stock under an employee stock purchase plan, or selling stock so acquired does not generate "wages" subject to federal employment taxes (i.e., FICA and FUTA). It also would clarify that federal income tax withholding is not required in the event of a disqualifying disposition of stock acquired with a statutory stock option, or in connection with an employee stock purchase plan discount.

The IRS last year indefinitely extended its FICA and FUTA tax moratorium for statutory stock options after the agency threatened to end the moratorium effective January 1, 2003. Unless and until IRS issues further guidance, it will not assess FICA or FUTA taxes, or apply federal income tax withholding obligations, upon either the exercise of a statutory stock option or the disposition of the underlying stock. But many in Congress and in the business community still believe legislation is necessary to prevent IRS from lifting the moratorium in the future, given that the current statutory language does not include a specific exclusion for statutory stock options.

SAVER's Credit

Section 103 of the reported bill would extend the SAVER's credit through 2010. (The credit is currently set to expire after 2006.) It also would make more middle-income taxpayers eligible for the 20 percent credit. (Under current law, eligible taxpayers can take a credit of 10, 20, or 50 percent of qualified retirement savings contributions of $2,000 or less. The 20 percent credit is available to taxpayers with adjusted gross incomes between $30,000 and $32,500 if they file joint returns, between $22,500 and $24,375 if they file head of household, and between $15,000 and $16,250 in all other cases. The reported bill would expand the adjusted gross income range for the 20 percent credit to between $30,000 and $40,000 for joint filers, $22,500 and $30,000 for heads of household, and $15,000 and $20,000 for all other filers.) Finally, the reported bill would index the adjusted gross income limits for inflation beginning in 2009.

At a time when some employers are seeing a drop in 401(k) plan participation, these changes might encourage low- and middle-income employees to come back to their employers' plans (or sign up for the first time). By participating in the 401(k) plan, some employees could reduce their adjusted gross incomes enough to qualify for the SAVER's credit.

As introduced, H.R. 1776 would have repealed the 2006 sunset date for the SAVER's credit and increased the maximum credit amount from $1,000 to $1,100, among other things.

Other Provisions

In addition to the provisions detailed above, the reported bill includes a number of other provisions that will be of interest to tax-qualified retirement plan sponsors.

• Section 109 would create a 10 percent exclusion from gross income for lifetime annuity payments from tax-qualified defined contribution plans and section 457 plans maintained by state and local governments. The exclusion would apply during the first 5 years the distributee receives lifetime annuity payments for the entire taxable year, up to a lifetime exclusion limit equal to 50 percent of the IRC section 415(c)(1)(A) limit (currently $40,000).

• Section 201 would allow non-governmental defined benefit plan participants to make "qualified mandatory employee contributions" on a pretax basis. This would apply only to mandatory employee contributions (i.e., those that are required as a condition of employment, plan participation, or of obtaining plan benefits attributable to employer contributions) that do not exceed 2 percent of the participant's compensation.

• Section 404 would direct the Treasury Secretary to issue regulations providing governmental plans subject to the IRC section 401(a)(9) minimum distribution rules are in compliance if they comply with a "reasonable good faith interpretation" of the rules.

• Section 501 would change the required beginning date under the IRC section 401(a)(9) minimum distribution rules from April 1 of the year following the year the individual attains age 70-1/2 to April 1 of the year following the year the individual attains age 75 for the 2008 calendar year and beyond (the age would be 72 for 2004, 2005, 2006, and 2007).

• Section 502 would provide an exception to the catch-up contribution universal availability rule for plans qualified under Puerto Rico law. (This exception also appears in the IRS's final catch-up regulations.

• Section 503 would extend the PBGC's missing participants program to multiemployer plans and defined contribution plans.

• Section 504 would permit direct rollovers from tax-qualified retirement plans to Roth IRAs.

• Section 505 would increase from 2-1/2 months to 6 months the amount of time 401(k) plan sponsors have to correct excess contributions before the 10 percent excise tax is imposed, and specify the corrective distribution is to be taxed in the year of distribution.

• Section 506 would protect tax-qualified plans from disqualification because of inadvertent qualification errors.

• Section 602 would direct the Treasury Secretary to continue to update and improve the Employee Plan Compliance Resolution System.

• Section 603 would extend the moratorium on applying certain nondiscrimination rules to state and local government plans to all governmental plans.

• Section 604 would increase from 90 to 180 the maximum number of days for providing certain pre-distribution notices, including the 402(f) notice, to participants and beneficiaries.

• Section 607 would authorize the PBGC to pay interest on premium overpayment refunds.

Other Major Differences Between Introduced and Reported Versions of H.R. 1776

It also is worth noting several significant provisions from the introduced bill do not appear in the reported version. The most glaring difference is that the reported bill does not include any of the 401(k) reform provisions from Title XI of the introduced bill. This probably is due to the fact the House passed a comprehensive 401(k) reform bill (H.R. 1000, the "Pension Security Act") that addresses many of the same issues on May 14.

The reported bill does not include a provision from the introduced bill that would allow health flexible spending account (FSA) participants to contribute up to $500 in unused benefits each year to a tax-qualified retirement plan or a section 457 plan. The House appended a similar provision to its Medicare reform bill, which is now before a House-Senate Conference Committee. But that provision appears to be in peril because it is tied to the House's controversial health savings account proposals. (In general, the House Medicare reform bill includes provisions that would allow individuals to make deductible contributions to health savings security accounts and health savings accounts. Amounts contributed to these accounts could be used to pay out-of-pocket medical expenses on a tax-favored basis.)

Also missing from the reported bill is a set of provisions relating to retiree medical benefits. The introduced bill would allow retirees to use "pension reduction" contributions to pay their share of retiree medical premiums, and authorize employers to set up 401(h) accounts in their profit-sharing and stock bonus plans. (Under current law, only pension and annuity plans can have 401(h) accounts.)

Finally, the reported bill does not include a proposed 50 percent excise tax on "excess employee remuneration" a company pays to its CEO or top 4 highest paid officers during a two-year period before the company files for bankruptcy protection.

The information in this Washington Bulletin is general information only and not intended to provide advice or guidance for specific situations. Contact your Deloitte advisor for information regarding your specific circumstances. If you have questions or need additional information about this article and you do not have a Deloitte advisor, please contact Martha Priddy Patterson (202.879.5634) or Robert B. Davis (202.879.3094). Human Capital Advisory Services, Deloitte LLP, 555 12th Street NW, Suite 500, Washington, DC 20004-1207. Copyright 2003, Deloitte.