Carol V. Calhoun

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.

It would be very difficult, if not impossible, for a private corporation to adopt a DROP plan. Such an employer would have to work around the ERISA restrictions on back-loading of benefits. It would also have to make sure that the plan, as a whole, did not discriminate in favor of highly compensated employees. I have not seen one that has found a way around these constraints.

Also, ERISA preemption does not extend to governmental plans. Thus, with respect to governmental 457 plans, state law may actually prohibit the higher contributions, not just impose state taxes on them.

You really have to look at the state law involved. The problem is that some state laws independently define a 457 plan, for example, as one that does not allow contributions over the old limits. Thus, if additional contributions (up to the new federal limits) are made, it could take away the state tax law benefit not only for the additional contributions, but for the plan as a whole.

I think you would have to look at applicable state and local law. However, in order to constitute a 414(h) pick-up, the salary reduction would have to either be mandatory, or irrevocable once the employee made it. Thus, failing to reduce the employee's salary would in effect result in paying an employee more than the salary to which s/he was entitled. Unless the extra payment was ratified by the body with authority to set employees' salaries, it would presumably be out of compliance with law. Again, you would have to look at state or local law to determine what actions would be required, and by whom, in order to recoup the excess. As a practical matter, most governmental entities end up giving the employee some reasonable period to repay if the error was not the employee's fault.

In the context of a governmental plan, the assignment and alienation rules do not apply, so in theory a plan could provide for division of benefits pursuant to a settlement agreement. However, if this were done, the agreement would not be a domestic relations order for federal tax purposes, so the employee (not the alternate payee) would be taxed on the distribution. As a practical matter, it has been my experience that either applicable state or local law or the plan document always requires a court order, rather than just a settlement agreement ratified by the parties. However, a Final Judgment of Dissolution of Marriage/Marital Settlement Agreement can be a domestic relations order if it is issued by a court or incorporated by reference into a court order (which would typically be the case).

Anyone who is interested in this topic may want to check out the American Benefits Council's fact sheet on "State Tax Conformity with Retirement Provisions of EGTRRA Federal Tax Law."

If the third-party administrator is paying claims without adequate documentation, you run the risk of the entire arrangement being treated as a nonaccountable expense reimbursement arrangement. In that case, all of the amounts paid to employees, not just those that exceeded their actual expenses, would be includible on their Forms W-2.

ALI-ABA puts on a course called "Retirement, Deferred Compensation, and Welfare Plans of Tax-Exempt and Governmental Employers," which typically deals extensively with 403(B) issues, in Washington, DC each September. You can still see the program for this past year's conference (which was supposed to be in September but got postponed until December due to September 11) at http://www.ali-aba.org/aliaba/CG003.HTM

I'm making the assumption here that you are with the insurance company writing the annuity contract, as opposed to the employer maintaining the plan. Presumably, whatever contract you write would have to be approved by your state insurance commission? I don't know whether you can get any information on forms of contracts which have been approved in your state. If you want to see the 403(B) audit guidelines, they are available by clicking here. However, they were issued in May, 1999, and have not yet been updated for EGTRRA. Alternatively, you might want to look at Publication 571, which was recently updated for EGTRRA. But in either case, remember that you are developing only the contract for the investment medium, not the plan document. Thus, matters such as who is covered, whether there are employer contributions, etc., would typically be covered by the employer adopting the 403(B) arrangement, not by you. What you need to do is to make sure that the contract terms do not cause the employer to be unable to comply with 403(B).

In all the cases I've seen, the employer either pays the daycare provider directly, or reimburses the employee only for documented expenses. Thus, there is no adjustment necessary, because reimbursed expenses are always equal to documented expenses. The deduction from the employee's paycheck should not be adjusted, even if actual expenses are less than anticipated.

Why would you need to adjust W-2 income for this? If the employee set aside a specific amount for dependent care under a properly constructed cafeteria plan, that amount is excluded from W-2 income. If the employee then fails to have enough expenses to use up that money, he or she will lose the money, so this situation would not require an amendment of the W-2. Was there some kind of error in reporting this initially?

Unlike the limits applicable to 403(B) and 401(k) elective contributions, the limit for 457(B) plans applies to the aggregate of employer and elective contributions. Some governmental entitities get around this issue by having only the elective contributions made to the 457(B) plan, and having the employer match made to a separate 401(a) or 403(B) plan.

Are we talking about a governmental 403(B), a church 403(B), or a 403(B) of a private tax-exempt employer?

Yes, the contract can lose 403(B) status. You might consider one of the IRS correction programs if this has been going on long enough so that there is potential back tax liability.

It's not the "eligible" part that's the hang-up, it's the "distributions." Until you have the right to receive a distribution from the plan, the eligible rollover distribution rules don't apply, so you're stuck with the transfer rules, which are much more restrictive.

Here is the Department of Labor regulation on the subject: This is the typical basis on which mandatory retirement is imposed on public safety personnel. However, even to the extent it applies, it permits only mandatory retirement. It would not permit the employer to restrict contributions by an employee who was still employed after age 70.

The answer in English is no. A transfer while you are still working and are not entitled to take a distribution from a 403(B) can occur only (a) in the form of a Rev. Rul. 90-24 transfer to another 403(B), or (B) to a qualified (401(a)) governmental defined benefit plan to purchase service credit.

llaplount, check the instructions to the 2002 Form 1099-R and 5498. (The document you will go to if you click on the link is a pdf document, so it requires the Adobe Acrobat reader, a free download, to read or print.) This was an EGTRRA change.

IRC 401 I think you and I are actually agreeing here. All I said was that if the arrangement was properly structured (e.g., fixed price, option price not less than 20% of the FMV of the stock on the date of the grant of the option, etc.), I think it works. I would agree with you that many of the current variants of the mutual fund option plan are much more aggressive than that, and thus would not be considered "properly structured" within the meaning of my first comment.

The issue of deeply discounted options is one of the reasons I added the weasel words, "if properly structured," to my original post. To the extent that the option exercise price is too low, I would agree that what you have is not really an option. At the time we looked at the issue, it appeared that 20% of value was a minimum. At the same time, an option has a value under Black-Scholes even if the exercise price at issue is exactly the same as the value at issue. This is because there is some calculable value to being able to wait x period of time (with no possibility of the losses you might experience if you actually owned the stock) and buy it only if the exercise price on the date the stock is purchased is less than the value on that date. Thus, it is at least in theory possible to structure an option plan in which the options are not discounted at all, have a value under Black-Scholes, but are treated as having no ascertainable value under the regulations. Such a plan would appear to work under the current regulations. Of course, as IRC 401 points out, the regulations predate Black-Scholes, and may well be modified in the near future.

Federal tax law used to limit people to no more than one salary reduction agreement per year, but that law has long since been repealed. Thus, the only reason that open enrollment would be limited to once a year would be if the plan's terms, or applicable state or local law, imposed such a limitation.

To the extent that they are treating the situation as a spin-off of a portion of the plan, followed by a termination of the plan covering the transferred employees, pre-ERISA section 401(a)(7), applicable to governmental plans under Code section section 411(e)(2), requires full vesting of all funded benefits upon plan termination.

The argument that the vendors are making is that these options do not have a "readily ascertainable fair market value" so long as they cannot be traded on an established market. There is language in the regulations which supports this view, which is why we think they work under existing regulations. But, as you say, that regulatory language may well be modified.

I've moved this to the Governmental Plans board, because it appears that it deals with a governmental plan that is not a 457 plan. Whether the situation represents a partial termination (or complete discontinuance of contributions, which would also require full vesting) depends on whether the employees can continue to receive contributions and accrue vesting credit with the new employer. One way of dealing with the situation is merely to provide that all account balances will be transferred to the new employer's plan (assuming that both the old and new plans are 401(a) plans), and that the new employer will credit service in determining vesting with respect to both the money transferred over and the new money. This avoids either (a) a situation in which the old employer has to figure out what service the employees have with the new employer, when the old employer may not have access to the new employer's payroll records, or (B) a partial termination, requiring full vesting. Alternatively, you could treat the switch to the new employer as having terminated the employees' service with the old employer. That would require full vesting of account balances. You could also provide that employees could receive a distribution of their account balances at that time. In that instance, they would be able to roll over the money to the new employer's plan (if it permitted such rollovers) or to an IRA. Again, you would need to consult state law to determine whether it mandated and/or permitted either of these options.