Carol V. Calhoun

Assuming that the plan is nongovernmental (and the original post refers to the employer as a "not-for-profit," I would be concerned about its exemption from ERISA, even if all contributions are salary reduction contributions, if the employer holds onto participant contributions for an excessively lengthy time. One of the requirements for the ERISA exemption is that I would be concerned about whether the employer would be deemed to have received indirect compensation if it held participant contributions (that it would otherwise have had to pay out in wages) for a substantial period, during which time presumably it would be receiving the benefit of earnings on the amounts.Obviously, the situation is not nearly as concrete as if this involved a 403(B) with employer contributions (which would clearly be covered by ERISA) or a even a governmental 457(B) plan (for which the model amendments to comply with 457(g) specify a 15-day period). However, I am not sure we can assume that there is no time deadline.

Whether the plan is governmental or not basically depends on whether you were a public or private school teacher. If public, it's a governmental plan, if private, it is not. I would definitely try to get the contract. If you can't get it from your ex-husband, the company should give you a copy.

A written plan document is required. See Treas. Reg. § 1.401-1(a)(2), which states as follows: Thus, a qualified plan must always be written.If the superintendent receives the money after having both (a) attained age 55, and (B) terminated employment, it will be subject to income taxes, but not to the additional tax on early distributions. IRC section 72(t)(2)(A)(v).

IRC section 401(a)(2 requires that "under the trust instrument" certain things be true. Based on this, Treas. Reg. § 1.401-1(a)(2) states as follows: The IRS has in turn interpreted the requirement of a written program to mean that the plan must be operated in accordance with that written program; otherwise, the requirement would be meaningless.

There were some GUST changes with which the plan should have complied--e.g., USERRA provisions. However, the IRS appears at least informally to be taking the position that unlike a 401(a) plan, which has a written plan document requirement under 401(a)(1), a 403(B) plan does not have any requirement of a plan document on the IRS side. Thus, it is looking at actual compliance, as opposed to plan amendments. The plan would be covered by ERISA, and should therefore be amended in such a way that the written document reflects actual practice. However, the ERISA time deadlines are less clear, and the penalties do not include loss of favorable tax status. Thus, in many instances an employer that discovers it has a problem like this merely amends for the future, but does not treat the plan as having lost 403(B) status for the past.

Unfortunately, this would really require looking at the specific contract to see what it says. If it is a governmental 403(B) plan, you'd also need to look at applicable state and local law.

The first source is Code section 401(a)(5)(G), which reads as follows: Code section 401(a)(3) and (4) are the paragraphs that impose the rules that prevent benefits under most nongovernmental plans from discriminating in favor of highly compensated employees.The second source is Code section 410©(1)(A), which reads as follows: Code section 410 is the section that imposes the rules that prevent coverage under most nongovernmental plans from discriminating in favor of highly compensated employees.The third source is Code section 401(a)(26)(H), which reads as follows: Code section 401(a)(26) is the paragraph that imposes the rules that prevent most nongovernmental defined benefit plans from covering less than (i) 50 employees of the employer, or (ii) the greater of--(I) 40 percent of all employees of the employer, or (II) 2 employees (or if there is only 1 employee, such employee).Together, these three sources permit a state or local government plan to cover only one employee, even if that employee is a highly compensated employee, without providing comparable benefits to other employees under any other plan, so long as this is permissible under applicable state and local law.

We have on occasion provided that the benefits under the plan shall be as provided by the Board of Trustees, which shall make its judgments in the form of written documents which shall be considered amendments to the plan document. I would think that you could do something similar with union contracts, provided that this is permissible under applicable state and local law. There is no federal requirement that the entire plan be incorporated into one written document. Indeed, we have been successful in providing, for example, provisions from a state constitution, a statute, a set of regulations, and a set of administrative procedures to the IRS as the "plan document" when requesting an IRS determination letter on a plan. The only thing to remember is that if any employee requests a copy of the "plan document," the office responsible for providing it should be instructed to give the participant copies of all documents that make up the plan document.

Ellie, you're right, I've seen a few of those, too, and should have clarified that in my response. The advantage is that they get to worry about only one federal law instead of 50 different state laws.

As to governmental 457 plans, there have been numerous issues about conforming state law to EGTRRA. You might want to check out the thread available by clicking here on that subject. With regard to 401(a) plans, few of the EGTRRA changes were mandatory for governmental plans. Thus, the major issue has been the extent to which plan sponsors want to amend plans to take advantage of new flexibility.

Joel-- You're right that the plan sponsor receives growth in excess of the Assumed Investment Return adopted by the plan's actuary. (And conversely, the plan sponsor takes the risk of growth less than that of the Assumed Investment Return.) All I was pointing out is that the Assumed Investment Return is itself a form of earnings to the participant, in the sense that what the participant puts in will, if mortality assumptions are correct, be less than what the participant takes out. This Assumed Investment Return (along with the advantage of not outliving the account balance) must be compared to the earnings on and advantages of other forms of investment available to the participant.

Typically, the amount necessary to purchase service credit is calculated in such a way that the employee in effect receives some further growth of the invested assets. However, the rate of earnings assumed for this purpose varies greatly from one plan to another. And of course, there is a trade-off involved: in a defined benefit plan, you cannot typically invade capital once annuitization has occurred, but you also will not outlive your assets if you live longer than the mortality tables would indicate. As with so much in this area, the employee needs to consider carefully the financial aspects of his or her choices, not just the tax consequences.

A governmental or church 403(B) is never subject to ERISA. Other 403(B) plans are subject to ERISA unless they meet a limited exception in 29 CFR § 2510.3-2(f) for 403(B) plans that contain only employee deferrals. For a copy of that regulation, you can click on this link and then scroll down to subsection (f).

The reason the legislation did not deal with 401(k) plans is that an in-service transfer from one qualified plan to another (for any purpose) was permitted even before the legislation. (In the context of a private plan, such transfers require the preservation of 411(d) rights, but of course section 411 does not apply to governmental plans.) The legislation simply expanded the permissible transferor plans to include 403(B) and governmental 457(B) plans, but only under limited circumstances. (My understanding is that the major reason for the limitations was the opposition of 403(B) and 457(B) vendors to the potential loss of those accounts.)

If amounts can be rolled over to the DB plan, why could they not be used to purchase service credit? The only relevant statutory language dealing with purchases of service credit states that a transfer from a 403(B) or 457(B) to a DB plan can be used only for the purchase of service credit. But that language merely prohibits transfers from a 403(B)/457 plan to a qualified plan at a time when a distribution is not otherwise allowed, unless such transfer is for purposes of purchase of service credit. In my view, once you are entitled to a distribution (and thus a rollover) from a 401(a), 403(B), or goveernmental 457(B) plan to a defined benefit plan, the rollover can be used for the purchase of service credit if the DB plan so provides. Section 415(n) deals with how after-tax contributions to purchase service credit will be treated for purposes of the limitations on contributions and benefits of sections 415(B) and ©. Before it existed, all after-tax contributions were subject to the section 415© limits on annual additions. In many instances, this prevented the purchase of service credit, because purchasing many years of service credit in one year would cause the amount of the purchase to be above the then-existing limits of 25% of compensation or $30,000. The effect of section 415(n) was to permit such purchases instead to be subject to the 415(B) limit on total benefits. Since that limit is not applied to each year's contributions, but to the total benefits payable, a purchase was less likely to cause a violation. The section 415(n) definition of a purchase of service credit is cross-referenced in the new rules allowing for plan-to-plan transfers to purchase service credit at a time when a distribution is unavailable. However, since the 415(B) and © limits do not apply to rollovers (as opposed to transfers), section 415(n) does not apply to them.

Thanks for the endorsement! By the way, I never call the IRS help line, for reasons of which you are fast becoming aware. If you have any sort of technical issue, and know which Code section you're interested in, there is an online IRS Code and subject directory that will tell you which actual human at the IRS deals with your Code section. Even in those instances in which the directory is out of date, the chances are excellent that calling that number will put you in touch with the current human in charge of that Code section. (This is also a nonpaid political endorsement--I have no connection with them. )

Perhaps an example will make this clearer. Assume a 457(f) plan with a 10% contribution formula, a 7% rate of return, and contributions all made on the last day of the year. Assume further that on the date of her marriage (which is the first day of year 5), the employee gets a huge promotion, and goes from a $30,000 salary to a $100,000 salary. Year 1 Employee not married Salary $30,000 Compensation deferred: $3,000 Total at end of year: $3,000 Year 2 Employee not married Salary $30,000 Compensation deferred: $3,000 Earnings: $210 Total at end of year: $6,210 Year 3 Employee not married Salary $30,000 Compensation deferred: $3,000 Earnings: $435 Total at end of year: $9,645 Year 4 Employee not married Salary $30,000 Compensation deferred: $3,000 Earnings: $675 Total at end of year: $10,320 Year 5 Employee married on first day of year Salary $100,000 Compensation deferred: $10,000 Earnings (all on separate property): $722 Total separate property at end of year: $11,042 Total community property at end of year: $10,000 Year 6 Employee married Salary $100,000 Compensation deferred: $10,000 Earnings on separate property: $773 Earnings on community property: $700 Total separate property at end of year: $11,815 Total community property at end of year: $20,700 Year 7 Employee married Salary $100,000 Compensation deferred: $10,000 Earnings on separate property: $827 Earnings on community property: $1,449 Total separate property at end of year: $12,642 Total community property at end of year: $32,149 Year 8 Employee married Salary $100,000 Compensation deferred: $10,000 Earnings on separate property: $885 Earnings on community property: $2,250 Total separate property at end of year: $13,527 Total community property at end of year: $44,399 Year 9 Employee married Salary $100,000 Compensation deferred: $10,000 Earnings on separate property: $947 Earnings on community property: $3,108 Total separate property at end of year: $14,474 Total community property at end of year: $57,507 Year 10 Employee divorces on last day of year Salary $100,000 Compensation deferred: $10,000 Earnings on separate property: $1,103 Earnings on community property: $4,025 Total separate property at end of year: $15,487 Total community property at end of year: $71,532 Thus, at the end of year 10, which is the date for division of property, the total benefit is $87,019. The nonemployee spouse's share of that is 50% of $71,532, or $35,766. This is not equal to 30% of the total benefit. (30% of the total benefit would be $26,106.) If the court goes through the calculations I just went through, and declares the nonemployee spouse's share to be $35,766, presumably there is no tax. However, the court may well not do that. If the parties have entered into a separation agreement that says that the nonemployee spouse's share of the plan will be $30,000, the court may well just ratify that agreement without comment. If both parties were well represented by counsel, the reason the parties agreed to the share of the nonemployee spouse being only $30,000, not $35,766, would presumably be because the nonemployee spouse was getting more than his share of cash or some other item of community property. Thus, in theory, the nonemployee spouse has "sold" $5,766 of his share of the plan to the employee spouse in exchange for that cash or other item of property. The question is, in this circumstance, is the nonemployee spouse taxed on the $35,766 value of his community property interest in the plan, even though he got only $30,000 of it? And if so, who is responsible for making the calculation to determine that the value of his community property interest is $35,766, if the court approves only a general separation agreement? And these facts are relatively simple, as such things go. In the context of a db plan, if the investment return varied from year to year, if the employment, marriage, and divorce did not all fit neatly at the beginning or end of a year, etc., the calculations could quickly turn into a complete nightmare.

The problem is that if an employee participated in a 457(f) dc plan for 10 years and was married for 6 of those years, it would not necessarily be true that 60% of the benefit would be a marital asset. For example, if the employee's salary had risen sharply over the 10-year period, but investment returns had not been that great, you might find that 90% of the benefit was attributable to the last 6 of the 10 years of plan participation. In that case, the spouse's share should be 45%, not 30%. If the spouse took 30%, wouldn't s/he be taxed on the 15% s/he presumably gave up to get other assets? And that's just in the context of a dc-type plan. If it's a db-type plan, the calculations can get even stranger.

Yeah, that's the main reason I wrote the Governmental Plans Answer Book--one too many times of someone asking me what to read to learn about this area, and my not being able to come up with any suggestions.

I'm not sure that it's really true that the community property share of a 457(f) benefit is always 50%. For example, suppose that the parties were married for some but not all of the term of employment that gave rise to the benefit, and the court assigned the employee spouse 60% of the total benefit from the plan while the nonemployee spouse got 40%. Is it then up to the parties to determine whether the nonemployee spouse in fact (a) got his or her 50% share of that portion of the benefit accrued during the marriage, (B) got less than 50% of the portion of plan accrued during the marriage in exchange for getting other (nonplan) assets, or © got more than 50% of the portion of the plan accrued during marriage in exchange for giving up other assets? In many instances, property divisions in a divorce are not really worked out through a court decision that values each property right separately, but through a court ratification of the parties' overall agreement as to who is to get what. Thus, the court may never explain what value it would have given to each party's community share of the plan itself. If the parties in fact were married for the entire term of employment, and no more than the term of employment, you're right that dividing the plan so that 50% went to each should not give rise to taxation. But it seems to me that there could be a lot of situations (particularly those in which the 457(f) plan is structured as a defined benefit plan rather than a defined contribution plan) in which the calculation of the division would be more complicated than that.

Actually, it would appear that in a community property state, each spouse might be taxed on a 50% share, regardless of which spouse actually received the payments. See Johnson v. US, 135 F.2d 125 (9th Cir. 1943). Footnote 8 in Balding v. Comm'r, 98 T.C. 368 (1992) specifically reserved the question of whether the Johnson holding would apply to the ultimate payment of benefits under a nonqualified deferred compensation plan. And of course, under section 457(f), the tax would be imposed when the amounts became vested, not necessarily when they were paid. This question is not merely academic. Courts do not necessarily divide each asset in accordance with community property laws. For example, a court might assign an employee spouse the right to 100% of unfunded deferred compensation, in exchange for the nonemployee spouse receiving 100% of the value of the family home. Would the nonemployee spouse nevertheless be taxed on 50% of the amount includible in income under section 457(f)? And if the parties were not married during the entire term of employment, things get even murkier. Suppose the parties were married for 5 years, and one of them had an unfunded plan that promised to pay out 2% of compensation for each year of service. Would someone have to figure out the actuarial value of the portion of the benefit accrued during the marriage, and would the nonemployee spouse be taxed on that? Moreover, the calculation would presumably have to be made by the employee and the spouse, not the plan. Under TAM 199903032 (October 2, 1998), the employer's income tax withholding and reporting obligation does not necessarily follow the actual inclusion in income by the employee and/or spouse.

The reference to ADP was just a direct quotation from the revenue procedure, which covers all 402(g) excesses, not just those in 403(B) plans. You're right that it wouldn't be relevant to a 403(B) plan. The issue really is whether the employee's obligation to report all "income" under section 61 is dependent on the employer's obligation to report the amounts under section 6051. I do not believe that it is. See, by analogy, TAM 199903032 (October 2, 1998), which held that an employee was required to include in income under 457(f) a contribution to an early retirement program even though the employee was not required either to withhold on the contribution or to report the contribution on the Form W-2.

It would seem to me that the employee would be obligated to report amounts that he knew should have been included in his income, regardless of whether the employer did an amended W-2. Of course, one gets into the question of whether an individual ever has an obligation to file an amended return if the first return was filed in good faith and the employee learns of the error only after that. However, that would cover only the year 2000 return; the excise tax is payable every year until the distribution. I think the issue of whether the employer revises the W-2 goes only to the issue of audit risk, not to whether the amount is taxable. Moreover, at this point, if the employee amended the 2000 return for some unrelated reason knowing that there was an overcontribution, I would have a hard time justifying a statement that he would be able to fail to report the income just because the employer got it wrong.

You might want to look at one of the correction programs on this. Under Rev. Proc. 2001-17, "The permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable in the year of deferral and in the year distributed. In accordance with [Treas. Reg.] section 1.402(g)-1(e)(1)(ii), a distribution to a highly compensated employee is included in the ADP test; a distribution to a nonhighly compensated employee is not included in the ADP test." Depending on the circumstances (e.g., how many errors like this there have been for this plan, whether the employer corrects voluntarily or decides to take the audit risk), the employer may also suffer penalties for failure to monitor the 402(g) testing in the first place. However, those are presumably not your client's problem.

Is this a 403(B) annuity, or a 403(B) custodial account/mutual fund? And did the overcontribution exceed the maximum exclusion allowance limits, the 402(g) limit on elective deferrals, or the 415 limits? The rules on what to do about overcontributions will vary depending on the answers to these questions, so a few more facts would help me simplify my response.