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Guest JMKirschbaum

409A and 105(h) discriminatory retiree medical plans

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Guest JMKirschbaum

Can anyone point me to any commentary that discusses the impact of 409A on self-funded retiree medical plans that discriminate in favor of highly compensated individuals?

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I don't believe that 409A has any impact on self-funded retiree medical plans that are discriminatory. The proposed regs carve out from the definition of nonqualified deferred compensation "a health reimbursement arrangement that satisfies section 105 and section 106." The fact that a self-funded plan may be discriminatory doesn't mean that it doesn't still fall under section 105 -- there is just tax consequences for HCEs. Besides, it's hard to envision how the requirements under 409A would ever apply to these plans.

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Guest Harry O

I think 409A will clearly apply to discriminatory plans under 105(h). In fact, 409A is raising the stakes on determining whether a plan is discriminatory. I think many folks were a bit lax in the past in recognizing and owning up to problems under 105(h). Now 409A raises the stakes since if you are wrong, not only are some or all of the benefits included in income but you also have a 20% penalty tax.

There are ways to fit these plans under 409A but they are admittedly cumbersome and will force changes to basic plan designs.

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Guest JMKirschbaum

I would have thought that davef is correct. When you look at the proposed regulations and how the exception for welfare benefits is stated it indicates that programs NOT included in the definition of nonqualifed deferred compensation plans include ". . . any other medical reimbursement arrangement, including a health reimbursement arrangement, that satisfies the requirements of Section 105 and 106." I read that as davef does - the plan satisfies 105, its just discriminatory. 105 does NOT say that discriminatory plans do not satisfy 105, only that the discriminatory portion of the benefits (NOT the entire plan) do not get the tax treatment that the rest of the plan does.

However, Dan Hogans at Treasury does not agree. He has stated that they are subject to 409A. I just cannot find anything that discusses it.

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Following are comments I made about this based on Notice 2005-1. My memory is that the same analysis applies under the proposed regulations.

Notice 2005-1, Q&A-3©: "The term nonqualified deferred compensation plan also does not include any . . . medical reimbursement arrangement . . . that satisfies the requirements of § 105 and § 106." This statement is not clear about whether a medical reimbursement arrangement that pays partially taxable benefits (because it violates the nondiscrimination rules in IRC Section 105(h)) "satisfies the requirements of § 105." The following from Treasury Regulation Section 1.105-11(a) suggests that a medical reimbursement arrangement that pays taxable benefits (because it violates the nondiscrimination rules in IRC Section 105(h)) would not satisfy the requirements of IRC Section 105 and so would be subject to the new rules in Section 409A:

"For amounts reimbursed to a highly compensated individual to be fully excludable from such individual's gross income under section 105(b), the plan must SATISFY THE REQUIREMENTS OF SECTION 105(h) and this section. Section 105(h) IS NOT SATISFIED if the plan discriminates in favor of highly compensated individuals as to eligibility to participate or benefits." (Emphasis added.)

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Guest mjb

How are payments under a discriminatory 105h plan subject to 409A since they are actually or constructively received in the year the services are performed by virute of being paid to providers of health services? If an employer makes a payment to a health care provider under a discriminatory 105(h) plan for a key employee, the payment will be included in the employee's taxable income in that year and the employee can deduct the payment as a medical expense under IRC 213. There is no legally binding right to deferred compensation in a future year since the employee is taxed as a cash basis taxpayer for all payments construcively received in that year.

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Guest mjb

The question under 409A is whether the employee has a legally binding right to retiree medical and secondly what is the value of the promise if there is one. If the employer can unilaterally terminate the plan without paying any benefits to the employee in a future year there is no legally binding right to deferred comp. In other words what is the comp that is deferred to a future year if all that is promised is reimbursement for future medical expenses for which the employer is not obligated to pay. No one has shown what is the legally binding right that will be paid in a future year since that will be contingent on what medical expenses are paid by the plan (fixed and determinable). If you really think about it the only right the employee has in any year under 105(h) is for medical expenses paid by the plan which is not a deferral of comp.

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mjb makes a lot of sense.

Medical benefits can be changed, or even terminated, once a year. There is no binding obligation for future benefits.

However, the FASB rule regarding other pensions and employment benefits will go into effect in stages over the next 2 years.

Employers, both public and private, will have to account for these benefits as liabilities.

And, these liabilities would be amortized as current.

So, although medical benefits are not guaranteed, they will appear on the financial statements as real liabilities.

Don Levit

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Guest mjb

I thought that under FAS 106 corporate employers were required for the last 20 yrs to show future retiree health benefits as a liability on their financial statements, e.g., GM has about a $100B liability for 600,000 persons. (Inside joke in in the financial community is that GM is really a health care provider that pays for its liabilities by selling automobiles.) The liability is for accounting purposes only and is not a legal obligation of the employer who can reduce the liabilty by terminating/reducing the retiree benefits or through bankruptcy. Pension liabilities are currently shown on the financial statements under FAS 87 which is suupposed to be revised.

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That "Medical benefits can be changed, or even terminated, once a year" is not necessarily correct, it depends on the contractual agreement with the retirees and the terms of that Plan.

That "There is no binding obligation for future benefits" also depends on the agreement, promises and terms.

I thought that to amortize meant that it was spread over a number of periods/years, whereas current meant taken as an expense in this accounting period. How can you "amortize as current " ?

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mjb:

I am not an accountant, but I have struggled through the FASB statements for public and private employers. From what I can gather, the liabilities for retirement medical benefits were detailed in footnotes, before these new FASB statements. Now, these medical retirement expenses are viewed very similarly to pension benefits. They will be considered as liabilities, so that the actual stock price of a publicly owned company will be affected by these expenses.

gburns:

As I understand the FASB statements, these retiree liabilities are to be paid over a period of time. If some of the participants are already retired, then the plan will generate current expenses.

Don Levit

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Guest mjb

Don: What does this change? GM's FAS 106 liabilities are greater than it's market capitalization which means that its net worth is less then zero but its not grounds for bankruptcy. By the way GM's pension liabilities under FAS 87 have been greater than its market cap for the last several years but it has not resulted in the price of the stock going to zero. I dont see how the medial care liabilities can be viewed the same as pension liabilities since most employers can terminate health care plans unilaterally without having to pay future benefits while pension plan liabilities cannot be cancelled except in bankruptcy.

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409A might apply to a VEBA that does not satisfy 105(h). There is a commercially marketed VEBA that reimburses employees (during employment and during retirement) for medical expenses from an account to which employer contributions are made over a period of years. I've not run this through the regulations, but my guess is this is deferred compensation.

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Everett.

Can you provide any information on this "commercially marketed VEBA "? I doubt that it could be regarded as deferred compensation since it is reimbursing an expense that was either incurred or made and is not otherwise available as cash, no different from either an employer paid FSA (or 105 MERP) or employer provide benefits credit in an FSA, but sometimes truth is stranger than fiction.

Don,

If "retiree liabilities are to be paid over a period of time" these are amortized expenses. You cannot do as you said and "amortize as current". What is paid now is current. What is to be paid in the future is amortized. In general, an expense is either current, deferred or amortized.

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