Carol V. Calhoun

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.

I would say that if you amended in 1992, you are stuck with the lower limits. (It is the terms of the plan in 1993 that govern.) Obviously, there is an unfairness in penalizing those who made the most efforts to comply, but Congress basically decided to live with that to resolve some state constitutional issues.

The issue is whether a state's regulation of all assets held by, or in a grantor trust for, a charitable organization would be preempted in the case of a particular grantor trust that provided the measurement of benefits under an unfunded plan. I would think it very difficult to argue that although ERISA treated the assets as not being part of the plan for regulatory purposes, regulation of them would still be treated as regulation of an employee benefit plan for ERISA preemption purposes. (In Barrowclough v. Kidder Peabody, the issue was the construction and enforcement of something defined under ERISA as a plan, albeit a plan ERISA chose not to regulate, and the issue of whether a rabbi trust is part of the plan never arose.) I suppose we'll have to wait for a court decision to know the answer to this one.

The issue you have here is that although neither ERISA nor the Internal Revenue Code requires you to comply with a QDRO, ERISA does not preempt any state laws regarding domestic relations orders in the case of governmental plans. Thus, the issue would be whether the laws establishing your plan (either directly, or by permitting the adoption of a suitable plan document) would take priority over the domestic relations laws--a question that would be determined entirely under state law. As a practical matter, what we normally do is to write back to whoever sent the order, and either say that the plan can't comply (citing whatever state statute or plan provision prohibits alienation of benefits) or that the plan needs more guidance before it can comply. Even if there is already an order out there, in most instances the order can be amended. And in general, a domestic relations attorney would prefer to work with you to come up with a reasonable order than to try to get involved in litigation with the plan.

The service provider is absolutely incorrect. As you suggest, the exclusive benefit requirement would prohibit, not require, payment of the benefit to the City. I'm a little bewildered as to how to counter the service provider's argument. It's sort of like someone who reads a sentence saying, "The sky is blue," and interprets this as meaning that the sky is orange--how do you prove the common meaning of words? In this case, how do you prove that a requirement that there be a trust for the exclusive benefit of employees does not mean that trust assets must be paid to the employer? However, you might at least cite some recent private letter rulings, e.g., Private Letter Rulings 200205007 (October 23, 2001), 200145006 and 200144007 (July 31, 2001), and 200131011 (April 26, 2001) for the proposition that it is permissible to have a benefit paid to a beneficiary in the event of the employee's death. And thanks for the kind comments about the Governmental Plans Answer Book!

Elective contributions to 401(k) and 403(B) plans are aggregated in applying the limits on elective deferrals of section 402(g). However, unless the 401(a) plan is a grandfathered 401(k) plan, this would not be a concern. Elective contributions to a 457(B) plan are no longer aggregated with elective contributions to a 401(a) or 403(B) plan for purposes of the 402(g) limit. (A glitch in EGTRRA which caused the compensation base for 457(B) plan purposes to be reduced by elective contributions has now been rectified by the Job Creation and Worker Assistance Act of 2002.) For section 415 purposes, contributions to a 401(a) plan, a 403(B) plan, and a 457(B) plan of the same governmental employer are never aggregated (although if a governmental employee has a separate business which has a 401(a) plan, 403(B) contributions on behalf of that employee must be aggregated with contributions to the business's 401(a) plan for 415© purposes.

State laws would not be preempted, because ERISA would not treat the assets as plan assets. (That's the only way the plan could be considered "unfunded.") But the state laws you would be concerned with would therefore not be those governing plan investments, but those governing investments of the employer. In some instances, state laws limit the types of investments charitable corporations can make.

I haven't seen cases on this. But I seriously doubt that courts would be terribly sympathetic. In the first place, the bankruptcy preferences are pretty mechanical, so sympathy wouldn't really help. Also, because these plans cover only the most highly compensated employees, a court might be inclined to believe that the participant was in part responsible for the bankruptcy. Thus, to the extent the court's sympathies played a part, I would see it as being more likely to be negative than positive.

A 457(f) plan is not subject to QDRO rules. Thus, it might have to comply with a QDRO that would not apply to other plans, but the employee would be taxed (for both income and FICA purposes) as though s/he had received a distribution if one were made to an alternate payee. The only question on FICA would be whether the distribution would have been subject to FICA if made to the employee. Presumably, an amount could not be subject to a QDRO if it were not vested, and if it were vested, it should already have been subject to FICA taxes under 3121(v).

Because the money is in theory the property of the separate employers, I cannot see that there would be a problem, so long as each employer has a separate share and there is separate accounting for each. The only real constraint would be to make sure that the investments, accounting, etc. were permissible for tax-exempt organizations under the laws of your state.

The fact that the state PERS does not treat these as employer contributions should not preclude a pick-up within the meaning of federal law, but you would have to look at any restrictions under applicable state law or the PERS plan document. Section 414(h)(2) came into being at a time when Congress was trying to tighten up the law to keep employees from arguing that mandatory employee contributions were not constructively received, and therefore were not includible in income for federal tax purposes. It responded by passing section 414(h), which generally provides that an employee may not treat a contribution as an employer contribution if the plan calls it an employee contribution. However, state and local governments made the argument that unlike private employers, they had no ability to modify their plan documents to call the contributions "employer" contributions, even if in fact the employer was paying them. To deal with this issue, section 414(h)(2) permits state and local governments to treat even those mandatory contributions called "employee" contributions under the plan document as employer contributions, so long as the employer, not necessarily the plan, takes the necessary action. With regard to the applicability of restrictions under applicable state law or the PERS plan document, we actually went through this many years back, at at time when the Virginia Retirement Systems had no provision for employer pick-ups. We represented a local jurisdiction that wanted to pick up employer contributions, but was concerned that if it did, such contributions would be subject to the plan's vesting schedule as employer contributions, rather than being 100% vested as employee contributions were. The member of the Virginia attorney general's office with responsibility for VRS confirmed that contributions could be treated as paid by the employee for Virginia purposes, even if they were technically "employer" contributions under federal law. Obviously, other states might take a different view, but this was at least helpful in the case of Virginia employers.

The bill text and Joint Committee on Taxation explanation of the portions relating to pension funding and EGTRRA technical corrections affecting benefits are now available by clicking here.

The bill text and Joint Committee on Taxation explanation of the portions of the bill relating to pension funding and EGTRRA technical corrections affecting benefits are now available by clicking here.