Ken Davis

Will a non-owner employee newly hired in the current year ever be a HCE for the current year? Given the wording of the statute (requires compensation in the preceding year) I don't think so, but thought I'd ask the experts. Thanks, Ken Davis Univ. of South Alabama

GBurns, I don't follow your comment about my "confusion." Isn't an FSA a type of arrangement that must satisfy the section 125 cafeteria plan rules to avoid constructive receipt of income when the employee makes the decision to reduce salary and fund the account? That's why I mentioned both together. Regarding the benefit to the employer, I thought I described a fairly common type of FSA. Since a DCAP is something that is usually used by only a small percentage of employees, and employers are not usually inclined to add this benefit on top of salary because of the amount, the salary reduction method seems to be the method of choice for funding the benefit. Maybe you see it differently. Ken

Rev. Rul. 75-539 states that sick leave accumulated at retirement that may not be received in cash but is used to purchase medical insurance is excluded from application of the constructive receipt doctrine. PLR 9840006 expands this concept to exclude from income excess annual sick leave used to increase the employee's account in a cash balance DB plan (again, the sick leave could not have been received in cash). Any reason why this concept won't work for excess annual vacation? For example, a state university currently allows an employee to have up to two times annual vacation in the bank. For vacation earned in excess of that amount, the employee must either "use it or lose it." The idea would be that on an annual basis, vacation that would be lost would be automatically converted to sick leave, which would then be converted to additional State Teacher's Retirement System benefits at retirement. Sick leave may be accumulated without limit and under our state laws is automatically used to "buy" more service credits under our TRS. Thanks, Ken Davis Univ. of South Alabama

Hello List, I just had someone from another listserv tell me that a cafeteria plan is not needed to avoid constructive receipt of income in the following circumstance. The individual seems to always give good advice, but this answer took me totally by surprise as it implies that the reimbursement account type of cafeteria plan is unnecessary. I'd like to get some opinions from this listserv. ""Are you saying that it is not necessary to use a cafeteria plan to avoid constructive receipt of income when an employee has a choice between receiving compensation in the form of cash or an otherwise tax-free fringe benefit? For example, an employer agrees to pay for its employees dependent care costs up to $2,000 per employee (in a program satisfying section 129) BUT ONLY if the employee agrees to reduce his/her salary by that amount. The employee elects to defer $2,000 at the beginning of the year. Is the use of a cafeteria plan required to avoid constructive receipt of $2,000 of compensation income?"" Thanks, Ken Davis Univ. of South Alabama

Governmental employer wishes to offer an employee an incentive of one year's salary to retire. The arrangement is voluntary. The offer would be made to only that one employee. The offer would be to pay one-half on 8/1/03 (which is when the employee would retire) and one-half on 1/2/04. The employee will not have the option to receive the money at any other times. Assuming the employer considers the incentive payment to be compensation, could this arrangement be considered a "severance pay" plan that would fall outside section 457(f) or is it clearly a "deferred compensation" plan subject to section 457? Thanks, Ken

Regarding a state DB plan with a 7/1-6/30 plan year. When 401(a)(17) was amended in '93 by P.L. 103-66, I'm being told that state employees hired before 7/1/96 were grandfathered in with no compensation limit under 401(a)(17). But several IRS Notices since then, including the latest (IRS Notice 2002-71), apparently say that a compensation limit does apply to those employees. Notice 2002-71 says the limit for 2003 is $300K. Which is correct? Pre-7/1/96 employees have no compensation limit, or the limit is $300K. Thanks, Ken Davis

Regarding a state DB plan with a 7/1-6/30 plan year. When 401(a)(17) was amended in '93 by P.L. 103-66, I'm being told that state employees hired before 7/1/96 were grandfathered in with no compensation limit under 401(a)(17). But several IRS Notices since then, including the latest (IRS Notice 2002-71), apparently say that a compensation limit does apply to those employees. Notice 2002-71 says the limit for 2003 is $300K. Which is correct? Pre-7/1/96 employees have no compensation limit, or the limit is $300K. Thanks, Ken Davis

Regarding a governmental DB plan, I have a question about the 415(B)(1)(A) annual benefit limit of $160,000. I'm not an actuary, so I'm only trying to get a basic understanding of what this limit means to an employee who has been in a DB plan for many years and has a relatively high income. For example, a public university faculty physician where the university does not have a separate faculty practice plan, i.e., both teaching and clinical practice income are paid by the university on one check. For example, assume one has worked for the university for 30 years, and the state teachers' retirement system general retirement benefit formula is 2% for each year of service. Assume a $300,000 average annual salary over the last 3 years (assume pre-'96 employment so not subject to the $200,000 annual compensation limit). The general benefit formula would result in a $180,000 annual retirement benefit. This is clearly in excess of the current limit of $160,000, so would the plan have language limiting the benefit to $160,000? And what of the requirement that each employee contribute 5% of his/her salary to the plan? Would the employee still be required to contribute 5%, even though the retirement benefit being "purchased" by this contribution, as a percentage of average salary, is less than one whose retirement benefit is under the 415(B)(1)(A) limit? Thanks, Ken Davis

Apparently, our College of Medicine Student Assembly has formed a VEBA. The purpose of the VEBA, as I understand it, is for the COM students to have COBRA coverage upon graduation or completion of their fellowship or doctoral studies. The insurance carrier would not offer COBRA through the health plan without a VEBA, since as a state institution we are not subject to ERISA. The students are broken down into three groups - (1) the MD student in the four years of medical schoot, (2) Physican's Assistant students, and (3) Post-doc fellows and PhD students. Groups 1 and 2 have no employment relationship with the University; they are purely students. Group 3, the post-doc fellows and PhD students are employees of the University. The VEBA offers current health insurance coverage, with Groups 1 and 2 paying premiums personally to the VEBA and the premiums for Group 3 being paid by the Univeristy to the VEBA. Form 5500 is being filed by the administrator (an insurance agency). Two questions: 1. Is filing Form 1024 to gain a 501©(9) exemption necessary for a VEBA that functions merely a pass-through for premiums and does not accumulate assets to pay benefits? In other words, is the 501©(9) exemption necessary (or desirable)? 2. May the VEBA cover Groups 1 and 2? 3. If the answer to 2 is No, then what is the consequence of providing such coverage? Thanks, Ken Davis Univ. of South Alabama

If a state teachers' retirement system offers an enhanced benefit in exchange for a voluntary contribution, but the years of creditable service are not changed, will 415(n) apply? For example, a person with 25 years service will normally receive a retirement benefit equal to 50% of compensation, but may increase the percentage to 60% with a voluntary lump-sum payment to TRS. If 415(n) doesn't apply, does that mean the voluntary contribution will have to meet the DC plan limits of the lesser of $40K or 100% of compensation? If 415(n) doesn't apply, does that mean that trustee-to-trustee transfers from 403(B) and 457(B) accounts may not be used to make the payment? Thanks in advance for any replies. Ken Davis Univ. of South Alabama

I understand that voluntary after-tax contributions to a DB plan that are not used to purchase permissive service credits are treated as employee contributions subject to the 415© DC plan limits. The 415(B) DB plan limits are not available. I'd appreciate it if someone would supply the cites (Code, regs, whatever) that say this is the treatment. Thanks, Ken Davis Univ. of South Alabama

Since beginning work at the university a group of faculty members also began work at a related 501©(3) organization, and received compensation from both employers. The "dual" employees will soon leave the 501©(3) and become 100% university employees. Their university compensation in the future will equal 100% of their present combined compensation from the university and the 501©(3). The state teachers' retirement system has told us the faculty members will retain their creditable years of service for purposes of calculating retirement benefits. But, without the faculty members buying enhanced benefits, the compensation on which their retirement benefits will be calculated will be proportionately equal to the ratio of their university compensation to total combined compensation, calculated immediately before their move to the university. I read PLR 200229051, which said that a voluntary purchase of enhanced benefits would not come under 415(n). The benefit would be equal to 2% for each year of service, up to 80% of compensation. As understand it, the reason given by the IRS was that the enhanced benefits related to years for which service credits were already been received, and this is not allowed under 415(n)(3)(A)(ii). But the ruling doesn't say what the effect would be if a participant made a voluntary contribution to purchase enhanced benefits. Can someone help me out with the effect? Does it mean that the plan must meet 415©, and can't use 415(B) [as would normally be available when voluntary contributions are made to purchase permissive service credits]? Any other effect? There are a couple of possible sources of funds for the purchase - aftertax cash and rollovers of qualifying distributions from existing 403(B) accounts (the 501©(3) doesn't sponsor either a 403(B) or a 457(B) plan). I assume trustee-to-trustee transfers from 403(B) and 457(B) accounts would not be available because the enhanced benefits do not meet the definition of permissive service credits. Correct? Thanks, Ken Davis Univ. of South Alabama

The professors in my university's college of medicince receive two paychecks. One from the university for teaching duties and one from the faculty practice plan, a separate 501©(3) organization, for their clinical practice of medicine. The FPP does not currently sponsor a retirement plan and it is being discussed that it may make sense to have the physicians become 100% employees of the university so that the state teachers retirement system will provide benefits on 100% of their compensation. We've received word from the TRS that moving the docs completely to the university will result in a reduction of the creditable years of service each doc has in the TRS. I think this is to compensate for the fact that the TRS, for all the years that two paychecks were handed out, received no contributions on compensation paid from the FPP. Without this reduction, TRS would be paying out benefits based on 100% of salary, while in past years contributions to TRS were made on only part of the salary. The TRS will give the docs the option to buy back the reduction of the years of service, but wants the money up front. Some amounts required to buy back the years are fairly large and the docs may not have other qualified retirement accounts that may be transferred to the TRS as the purchase price. So, it is likely that many docs will have to borrow the money from a bank to make the purchase and pay back the bank with after-tax dollars. Is this purchase covered by 415(n) even though they are buying back years which they agreed to give up to have their benefits calculated on 100% of salary? In other words, do years which had been credited to a person, but have been taken away, meet the definition of permissive service credit in 415(n)(3)? If 415(n) doesn't apply, then what are the possible consequences of a voluntary purchase with after-tax dollars? Thanks, Ken Davis Univ. of South Alabama

Okay, I may have found the answer myself. The last sentence of final reg. 1.457-2(f)(2) states "A prior taxable year includes a taxable year in which the participant was eligible to participate in an eligible plan sponsored by a different entity, provided that the entities sponsoring the plans are located within the same State. . . ." But this sentence was dropped in the prop. regs. published last May. Any idea why? Any idea when the prop. regs. will be adopted as final regs.? Also, I still have the question about coordinating the normal retirement ages if a university employees is able to piggyback the years during which he/she was eligible to participate in the State's plan onto the university's plan which came into existence on 1/1/02. Any thoughts? Thanks, Ken Davis Univ. of South Alabama

The University of South Alabama began sponsoring a 457(B) effective 1/1/02. The State of Alabama has sponsored a 457(B) plan since 1986. University employees may contribute to either or both plans, and have been contributing to the State's plan on a voluntary deferral basis since 1986. The University's plan has more investment options, so in the future it is likely that more employees will choose it rather than the State's plan. The vendor that supplied us with our 457 plan is saying that for purposes of the 457(B)(3) three-year catch-up calculation, the years during which an employee could have contributed to the State's plan (back to 1986) may be counted as years for our plan (even though our plan has only been in existence for one year). Are they correct? The University is considered a "public body corporate" and is able to issue tax-exempt bonds as a political subdivision of the State, if that helps. If they are correct, must our plan's normal retirement age of 65 be changed to agree with the State plan's NRA of 60? Thanks, Ken Davis Univ. of South Alabama

For an employer that sponsors two 457(B) plans, is it legal to have a different normal retirement age in each plan? Someone told me they thought the proposed regulations require consistency, which makes sense. To add a twist, what if the employer is a state university? The university sponsors its own 457(B) plan, and the state sponsors another 457(B) plan. University employees may contribute to either or both plans. Thanks, Ken Davis Univ. of South Alabama

Physician prescribed a bedroom be redone to control allergies. Replaced existing items with wood blinds and non-allergenic pillows, pillowcases, bedsheets, mattress and box springs. May the entire cost be reimbursed from a FSA? Would the answer be different if the existing items were old and ready to be replaced anyway, i.e., only reimburse the excess of the cost of non-allergenic items over the cost of similar-grade standard items? Thanks, Ken Davis Univ. of South Alabama

Wasn't it the amendment of section 457©, and not 457(B)(3), that repealed the coordination requirement? 457(B)(3) deals with the double limit during the last 3 years before reaching NRA. Ken Davis Univ. of South Alabama

The proposed regs., at 1.457-4©(3)(v), state that an entity sponsoring more than one 457 plan must have the same normal retirement age under all the plans. The State of Alabama sponsors a 457 plan that has a NRA of 60. All state employees, including employees of the Univ. of South Alabama, may contribute to the plan. Beginning 1/1/02, the University of South Alabama adopted a 457 plan for its employees, and uses a NRA of 65. If the wording of the proposed regulation is adopted in final form, must the University's 457 plan change its NRA to 60? Thanks, Ken Davis Univ. of South Alabama

Thanks again, Ellie, for your thoughtful comments. Ken Davis Univ. of South Alabama

Thank you for the information, Ellie. Do you know the statute or regulation on which the IRS is basing their position that allows some post-employment elective salary deferrals, but not others? Ken Davis Univ. of South Alabama

I was reading over the replies and have a question. Will someone please provide the IRC sections or Treas. regulations cites that will not allow an elective salary deferral for amounts received during retirement? For example, if an employee retires on 12/31/02 and receives his final paycheck on 1/1/03 ($5,000, consisting of regular biweekly pay and unused vacation), what laws or regulations specifically prevent the employee from electing to defer some or all of the $5,000 under 402(g) and 403(B)? Thanks, Ken Davis Univ. of South Alabama

I've been told by a vendor that the 3-year catch-up in 457(B)(3) may not be used in the year of retirement. And I would agree with this in a case where the employee retires on or after attaining normal retirement age. But what if the employee retires before attaining normal retirement age? What's to prevent the employee from using the catch-up in the retirement year, as long as the retirement year is one of the three taxable years ending before the year the employee would attain normal retirement age? The IRC states "1 or more of the particlpant's last three taxable years ending before he attains normal retirement age . . . ." It doesn't state "1 or more of the participant's last three taxable years ending before the year in which he retires . . . ." Assume the vendor's plan language regarding the catch-up provision is identical to 457(B)(3). Thanks in advance for any replies. Ken Davis Univ. of South Alabama

I'm aware that vendors are using both 401(a) plans and mandatory 403(B) plans to accomplish this.

They won't gain any tax advantage from participating in two DCFSAs. Part III of IRS Form 2441 computes the excess benefit received over $5,000 and adds it to income on Form 1040, line 7.