401 Chaos

To follow on Pax's reply, I think the use of ERISA-based documents is allowed. The problem comes in that these prototype documents include various ERISA-required provision that are not applicable to governmental plans and probably leave out a fair bit of provisions that you would ideally want to include in a governmental plan document. The result is that the plan sponsor ends up with a jumbled and confusing plan document that could potentially limit their options in ways not necessary or intended.

I am far from an expert in this area and would advise the individual to talk to an accountant or other tax professional regarding the facts of her particular situaiton but some general thoughts are as follows: As a general matter, recipients of gifted stock get a "carryover basis" meaning they take whatever cost basis the original owner had in the shares rather than the FMV on the date of gift. Obviously establishing carryover basis can be a challenge without careful records dating back to original purchase. Hopefully this is not an issue here. Also, given the small initial amounts involved here, it does not sound as if there should have been any gift tax issues for the original donors and, even if there were, that generally shouldn't be an issue for your friend nor should it matter what generation actually transferred the gift. (Note, the general rule envisions that each tranfer or sale is at a gain. The basis amount is different if the grandparents gifted the stock at a time when the FMV was less than the amount they originally paid.) A more significant question is whether the stock was inherited by any party rather than gifted. If so, the recipient is generally entitled to a "stepped-up basis" (i.e., basis equal to the FMV of the stock on date of death) rather than a carryover basis. This could be a significant break to your friend if say the stock passed from grandparents to parents by death and then parents immediately "gifted" the shares to your friend. Does your friend want / need to sale the stock now or is the potential sale all being raised as a result of the change in control of the bank? Obviously we don't know anything about the specifics of the transaction but generally such sales are structured so as to be tax-free or not to have tax impact on shareholders. The certificates would have to be redeemed for new certificates but she should be free to hold the stock without paying capital gains until some later disposition if she desires. Obviously the basis amounts gets jumbled a bit more as a result of the conversion of the shares but the real question I think is whether she thinks this new stock is a sound investment and wants to hold it or if she thinks the value may have peaked. There is usually a fair bit of information regarding the conversion formula and basis calculations included in the information provided to shareholders in such sales. At any rate, I do not think switching the old shares for shares in the new company should have the same tax affects as selling the shares. As for adjusting basis for stock splits, you generally reduce the original basis for each split fraction--for example, if a split is 2 for 1, you would get twice as many shares but your basis in each share would be 1/2 of the original. In short, the overall total basis amount is the same but the individual per share basis amount must be reducted to reflect the increase in number of shares.

Rcline, Thanks for your response. We definitely plan full disclosure to all parties as well as the IRS. I would be interested in what other types of arrangements others may have made in assigning responsibility for completing corrections post-closing, particularly the IRS's general recommendation or reactions to assigning responsibility in the stock purchase agreement. I'm sure Buyer would ideally want seller to terminate the Plan immediately prior to closing but that doesn't seem possible here given need for future corrections. If the plan is not terminated prior to closing in a stock deal, seems Buyer is generally stuck with responsibility for completing all plan corrections as a matter of law. Obviously parties can agree on indemnification and reimbursement by Seller to Buyer to cover future plan correction expenses but will IRS allow Buyer to avoid the administrative hassles of completing the correction if Seller agrees to do this? Unfortunately, deal has to be arranged as a stock deal rather than asset deal because client's primary assets are certain government contracts that cannot be assigned, only transferred as a result of a stock deal.

Does anyone have any experience with the sale of a company while they have an EPCRS application pending. In our situation, transaction will likely be structured as a stock deal for various reasons and Buyer will presumably desire termination of the 401(k) Plan prior to close. Seller, however, has an EPCRS application pending for various operational errors. Although a number of the errors were self-corrected, the Plan was still required to seek IRS approval for final corrections of certain errors. Approval and correction of those errors is not expected to be a problem as the Plan has proposed using standard IRS corrections. The problem is the EPCRS application has only been submitted for a couple of months and the proposed sale is being pushed up for various reasons. I would appreciate thoughts of anybody having dealt with a similar situation.

For what it's worth, we were involved in a DOL demutualization audit a couple of years ago. Although the employer continued to sponsor the same plan in our case, as in Kirk's example our client also had very high turnover. So high in fact that I believe less than half of the participants covered during the two Plan Years generating the demutualization proceeds were still around. In that case, the DOL agent we were working with was very pragmatic and did not balk at all about having the employer simply provide a premium holiday for current employees with no attempt to return amounts to former employees. The amounts were not terribly large in our case but, as with so many things, I think much of this just depends on the particular agent involved.

Mbozek and Dietpepsi, Regarding FICA taxation of employer contributions, do employer "matching" contributions contributed to a 401(a) plan operated in tandem with a 457(b) plan escape FICA taxes as with typical 401(a) contributions or is there any guidance suggesting that they should also be viewed as employer contributions under a 457(b) and thus subject to FICA taxes when deferred?

Is there any possibility that your client could be classified as a governmental entity or quasi-governmental entity rather than a general tax-exempt? I have seen some entities where the lines were blurred and thus resulted in establishment of a 457 for a governmental entity.

Vebaguru, Do you read Rev. Rul. 91-26 to extend the 2% S-Corporation exception to less than 2% members of an LLC? Assuming the LLC has elected to be taxed as a partnership, I have heard others interpret this as being governed by the regular partnership rules. Thus, any LLC member-employee, no matter how small of a membership interest they hold, would be considered self-employed and therefore ineligible to participate in a cafeteria plan. I don't think that is fair, particularly given the rise in LLCs in recent years and the trend to award employees nominal membership interests but I have generally understood there to be a bright-line prohibition if the individual receives a K-1 from the LLC. Thanks for any guidance you can provide.

I think they are still useful documents for the purpose of filing just one Form 5500 but the varying claims procedures for health plans versus disability plans versus other welfare benefit plans means that the claims processes may be difficult or confusing to cover in a single document and single SPD. Also, one recent concern that has arisen with wrap plans is whether a Wrap Plan that is considered a hybrid entity for HIPAA Privacy purposes and has a fuly-insured medical insurance plan but self-insured health FSA opens up the fully-insured plan and/or the wrap plan document to full HIPAA Privacy Rule requirements generally applicable to the FSA. I would be interested in hearing about others' thoughts as well.

This can be a complicated topic. One of the best resources I've seen on the distribution of insurance in qualified plans is in Natalie Choate's book, Life and Death Planning with Qualified Plans (see attached link). http://www.ataxplan.com/

Kaister, Thanks, I have seen that GHP definition and I still take exception to the point that a cafeteria plan itself might be considered an employee welfare benefit plan under ERISA even if it includes options for group health plans, health FSAs, etc. If the cafeteria plan is drafted so that the health FSA provisions are included in the same plan document as the regular cafe plan features, then that is a dfferent story but it has always been my understanding that a cafeteria plan alone is more in the nature of a fringe benefit plan subject to IRS regulation versus an employee welfare benefit plan under ERISA. Do you currently file a Form 5500 for the cafeteria plan? Do you file separate 5500s for the other plans? Perhaps the cafeteria plan you have basically serves as a wrap plan for consolidating all the various ERISA plans. I guess it is largely a matter of semantics but I find it frustrating to keep getting HIPAA Privacy guidance that confuses general ERISA classifications without more explanation.

I'm not a HIPAA expert but I wouldn't think you could simply amend a true cafeteria plan document to provide required HIPAA provisions for all component health plans. A cafeteria plan itself really isn't an ERISA employee welfare benefit plan nor would I think subject to the HIPAA Privacy Rule itself--it's really the individual component plans that are covered. I understand some plan sponsors have adopted a "Wrap Plan" document which essentially consolidates all of the various welfare benefit plans into a single ERISA welfare benefit plan for Form 5500 purposes. The plan sponsor then adopts required HIPAA amendment applicable to the covered health plans included in the Wrap document. There are also other combination techniques that may come into play such as ACEs and OCHAs depending on the particular facts.

I'll admit that it sounds like some advanced tax planning is being done in this case but I would like to respond to the above comments about keeping blinders on in reviewing DROs. While I agree it's not the Plan's job to second guess the motives of the parties, I do think all parties often benefit where the plan admiinistrator questions or confirms the intent of certain DRO division and distribution provisions. I routinely see poorly drafted orders that arguably meet the QDRO requirements but do not really make sense. When counsel is questioned about these provisions, we frequently find that the provisions are not as intended and the order gets revised. I would just caution plans not to put on complete blinders in reviewing DROs.

Andy H, I do not have much experience working with life insurance policies in plans so take this with a grain of salt but for some gift tax / charitable contribution purposes the "replacement value" of a fully paid-up life insurance policy may be used rather than the cash surrender value. If not fully paid-up, the interpolated terminal reserve value of the policy rather than the CSV is required. Not sure how that ties into the plan asset valuation context but it does seem that what the plan could receive upon surrender for these policies could be very different from their value if the individuals looked to replace this coverage. I'd be interested to hear how you finally decide to handle. Thanks.

Everett, just to be sure I'm clear, I'm assuming the determination request will be made along standard lines under Form 5300? Will the Service automatically rule on the partial termination issue when you submit the freeze amendment or do you have to specifically ask for that ruling?

Mike, Are all DB Plan freezes automatically considered plan terminations for Form 5310 purposes? What if the employer only temporarily freezes benefit accruals due to financial hardship and may possibly "thaw" the plan and continue contributions at a later date? If you have an underfunded DB plan that has been frozen with respect to future benefit accruals due to financial hardship but the employer is continuing to make required contributions to the plan and maintains the trust, etc. but has deferred a decision on whether the plan will be reinstated or terminated at a later date, would the initial amendment freezing the plan have to be filed under a 5310 or a 5300. The instructions to Form 5310 suggest that Form 5300 should be filed instead of a Form 5310 if a plan has "terminated" but the sponsor will continue to maintain the trust after termination.

Mbozek, Thanks for your response. The employer is a governmental entity and the existing 457 plan is an eligible 457(b) plan. While I am familiar with the general rules for 457 plans, I, like our client, have seen general references to combination plans along the lines of the earlier posts but have not found much in the way of detailed discussion as to how they operate. They would like to get a little better understanding of how these combo plans work before pursuing this with additional counsel. Any thoughts on additional information on the mechanics of such combo plans would be appreciated.

I unfortunately do not work with 457 plans that often but have a client that has inquired about setting up a 401(a) plan for matching contributions to the 457 plan. Is the benefit to this arrangement that it allows employers to provide a match to the 457 plan when they otherwise would not be allowed to do so under the 457 rules? Does this arrangement avoid including the matches in the 457 plan totals? Do the matches going to a 401(a) plan escape FICA when the employer contributions to a 457 plan would not? Could anyone recommend other resources that discuss these arrangements in detail. Thanks.

GBurns, Thanks for your response. That has always been my general understanding as well and what we generally concluded as well. The LLC here elected to be taxed as a partnership. The members were listed as "employee members" or something similar in an amendment to the ownership documents.

This is somewhat off the topic but I am curious if anyone considers de minimis LLC owners (individuals owning less than 2% of LLC interests) to be eligible to participate in employee benefit plans similar to rules for less than 2% S Corp. owners or does their ownership interest, no matter how small, prevent their participation? We have employees who have received relatively small LLC membership interests as bonus / equity ownership amounts but who otherwise are considered regular full-time employees of the LLC.

Katherine, Thanks for your response. Perhaps the dual election requirement--one for elective deferrals and a separate one for catch-up deferrals--is unique to our vendor because of the way their system tracks catch-up contributions but it is clear that catch-up eligible participants will be required to specify two separate election percentages as part of the enrollment process. Do I read your response to say that any limit on elective deferrals, although not intended to limit catch-up contributions in any way, could still generally be considered to operate as a limit on catch-up contributions? The plan has no problem with catch-up eligible participants deferring above the 50% amount if necessary to make full catch-up contributions but we do not want to change the 50% limit on elective deferrals just because of the new universal availability regulations unless we have to.

We have also found the DOL to be flexible and reasonable in accepting solutions to demutualization issues in earlier demutualization cases. The murky nature of the issues involved, the lack of clear guidance and the inability to ever craft perfect solutions for all involved seem to work in the plan sponsors' favor provided they use the proceeds to benefit plan participants / employees rather than simply taking the refunds into general assets.

Alf, If I understand your facts, your analysis matches my understanding of the new regulations. We have a similar plan that also limits elective deferrals to 50%but does not impose any limits or caps on catch-up contributions with the general thought that eligible participants ought to be able to defer as much as necessary to make full catch-up contributions. The recordkeeper for the plan, however, requires participants to elect a set percentage to be deducted from pay for both elective deferrals (e.g., percentage between 1% and 50%) as well as a specific deferral percentage for catch-up contributions. Given the current plan terms, I assume the participants should be able to elect any percentage between 1% and 100% for catch-up purposes. However, the ability of participants to elect 100% deferrals coupled with the new regulations and safe harbor exception have caused the Plan Administrator to question the 100% deferral ability. Thus, although the new cash availability limits do not appear applicable to the plan as currently drafted, the Plan Administrator is now considering changing the plan to include a cash availability limit. Have others had similar experiences and, if so, how are other plans responding?

I would agree that you could probably just call this it's own little health plan under 105(h) if you had to. I haven't researched the fringe benefit area lately but seems like there is probably something that would cover this--hasn't the IRS essentially allowed general first aid and minimal welfare benefits as de minimis fringes. Given their approval of holiday gifts and trinkets (i.e., the Christmas hams, etc.) that can be accounted for and valued without major issue, I would be inclined to argue these are similarly within the general first aid de minimis fringe (see Tax Management Portfolio # 394), particularly if you consider the benefits which on-site flu shots afford the employer (less absenteeism both in terms of initially receiving shots and in employees later contracting the flu, etc.) rather than any purely one-sided benefit to the participants.

I believe the Form 5500 instructions provide a fairly detailed discussion of the definition as well including reference to the definition provided under DOL Reg. § 2510.3-3(d). Note also that dependents of employees participating in welfare plans are not counted.