Are 419(e) benefits deferred compensation?

[Don Levit]

In section 404(b)(2)(A) it states, For purposes of this section, any plan providing for deferred benefits (other than compensation) shall be treated as a plan deferring the receipt of compensation. In the case of such a plan, the determination of when an amount is includible in gross income shall be made without regard to any provisions of this chapter excluding such benefits from gross income.

In section 404(b)(2)(B) it states, Subparagraph (A) shall not apply to any benefit provided through a welfare benefit fund (as defined in section 419(e)).

Don Levit

[vebaguru]

This is the position that the IRS is taking in some audits, although you correctly point out that such benefits are excluded under 404(b). IRS tries to bring it back in under the 402(g) rules which don't contain a similar exclusion.

The IRS has never prevailed in court on this position, and will likely not be able to do so. It is simply an issue they raise with some audits of welfare benefit plans which they believe to be thinly disguised deferred compensation plans.

[Don Levit]

vebaguru:

If it is not deferred compensation according to 419(e), why couldn't the employees make the contributions, before tax, through a section 125 plan?

Don Levit

[GBurns]

Section 125 has a very limited list of qualified benefits for which compensation can be pre-taxed. Is the contribution for one of these?

[Don Levit]

George:

No, it is not.

I find it interesting that HSAs are acceptable for section 125.

My point here is that if the 419(e) plan is not deferred compensation, it could be acceptable under section 125.

If it is not deferred compensation, then it could be, what, current compensation?

Also, the IRS considers that section 125 for VEBAs is a possibility.

Go to:

http://www.irs.gov/irm/part7/ch10s12.html.

Look at 7.25.9.14.

Don Levit

[GBurns]

Just because a VEBA is a Trust does not make it comparable to a 419(e) plan or trust. Do not let to coincidental appearance of the word "trust" mislead you.

It is not acceptable in a section 125 plan simply because it is not listed, nor for a qualified benefit.

The benefits in 419(e) plans are deferred benefits.

Usually, in my experience, 419(e) plans are employer funded.. There is no employyee contribution, so pre-taxing by the employee is not a consideration.

[Don Levit]

George:

I agree that the VEBA is not listed as one of the section 125 benefits.

However, it is a possibility, as far as the IRS is concerned.

Why would it list section 125 as a way to pay for benefits, if the employee wasn't paying at least part of the costs?

In addition, there are employee-pay-all VEBAs.

I will admit, those I have read about are all after-tax.

I'm just throwing this out for discussion's sake.

I am taking no particular position.

Why do you say that 419 plans are deferred compensation, when the 404 regulations say differently?

Don Levit

[J Simmons]

George didn't say that 419(e) plans are deferred compensation. He said they were deferred benefits. But for subparagraph (B), section 404(b)(2)(A) would treat deferred benefits as deferred compensation. However, subparagraph (B) exempts the treatment of deferred benefits as deferred compensation if those deferred benefits are provided through a section 419(e) employee welfare fund.

The IRS defines the same term differently for different contexts. The 2007 proposed Treas Regs at section 1.125-1(o) defines "deferred compensation" for the general prohibition against such in a 125 cafeteria plan:

A plan that permits employees to carry over unused elective contributions, after-tax contributions, or plan benefits from one plan year to another (except as provided in paragraphs (e), (o)(3) and (4) and (p) of this section) defers compensation. This is the case regardless of how the contributions or benefits are used by the employee in the subsequent plan year (for example, whether they are automatically or electively converted into another taxable or nontaxable benefit in the subsequent plan year or used to provide additional benefits of the same type). Similarly, a cafeteria plan also defers compensation if the plan permits employees to use contributions for one plan year to purchase a benefit that will be provided in a subsequent plan year (for example, life, health or disability if these benefits have a

savings or investment feature, such as whole life insurance).

[Don Levit]

John:

Thanks for providing your comment.

It does seem to put a lid on my theory.

Do you or anyone else have any theories as to why the HSA was exempt from deferred compensation?

Don Levit

[J Simmons]

The HSA is in many ways a hybrid. There are many unexplainables about an HSA if you are trying to reconcile it with previously established benefits tax principles. The only tax advantage to an individual to elect to fund into an HSA through a 125 cafeteria plan is FICA savings. Either through a 125 cafeteria plan or the individual making contributions on his/her own makes those contributions tax free.

By having it deducted on the employer's payroll through a 125 cafeteria plan elected paycheck reduction, it is an easy mechanism to exempt such amounts from FICA as well as a tax deduction.

It would add further complexities to Form 1040 for contributions by the individual outside of a 125 cafeteria plan to allow a FICA "deduction" too. So such is simply not allowed.

Since the individual contributions are tax free either way, perhaps the policy writers thought it would not significantly undermine the 125 prohibition against deferring compensation to allows cafeteria plans to permit employees to elect paycheck reductions and corresponding contributions to an HSA. And since it did provide a nifty mechanism for avoiding FICA on the contributions, the 125 cafeteria plan apparently was chosen for this purpose.

These are only my suppositions as to the reason that Congress chose to allow HSA contributions--which do defer compensation--to be made through a 125 cafeteria plan.

[vebaguru]

Funded HRAs are also hybrids, somewhat inconsistent with previously established benefits tax principles. It is funded entirely with employer moneys. But contributions by the employer are not subject to payroll taxes and neither are distributions for medical benefits. This is true whether funded through a VEBA or other funding arrangement.