Locust

Appleby - The SEP was set up in 2004 and contributions were made for 2004. The partnership has filed its tax return for 2004. I am thinking that the correction will have to occur under the voluntary correction program.

It's entirely a state thing, so some of our normal MEWA concepts may not work. Normally, you wouldn't have a MEWA unless there were unrelated employers, and I would think that all state entities would be considered a single employer. The more relevant issue is what state law applies. Government entities are restricted to exercising the acts specifically authorized by statute. In my state there are rules that apply to municipalities, counties, hospital authorities etc. that say exactly what these entities can and cannot do. There are personnel rules, and restrictions on investments, including insurance. There may be restrictions on insurance - such as you can't buy insurance except for certain purposes and from certain types of insurers. You may have an issue with this type of restriction. There may also be restrictions on what 2 or more entities can do together. For example, counties may not be allowed to consolidate their personnel departments, or their police departments. State law often allows "consortiums" where two or more entities get together to do something - such as a Regional Authority, etc. It really comes down to what the state law says - no ERISA or federal issues.

If it's a short term deferral, there may be help in ss 409A. Section 457 doesn't address this, but under the new ss 409A, short-term deferrals of 2 1/2 months or less are exempt from ss 409A. I would hope that this principle established under ss 409A would carry over to 457 - that is, short-term deferrals would not be subject to 457. The reasoning - if the arrangement is not within the limits of 457(b), it is governed by 457(f), which is subject to ss 409A. However, tax accounting principles might say that 457(f) says that you are taxed when vested, and that's that, even though the employee doesn't have the right to immediate payment. Caveat: There are many unanswered questions for ss 457 raised by ss 409A.

I can't see how this would be a prohibited transaction. The plan has nothing to do with the purchase. No fiduciary of the plan has any authority to direct Corp A. The fiduciary isssue, if there is one, is the purchase of a director's property - but this is not a plan issue, but a corporate issue.

The only transaction involving the plan is the purchase by plan of Corp A's stock. This may not be a prohibited transaction - probably not. However, prohibited transactions include transactions by the Plan directed by a "fiduciary" in which the fiduciary has a conflict of interest. An argument could be constructed that the participant had a conflict when he directed the purchase of Corp A's stock - he could expect to attain the director's position at Corp A as a result of the purchase, which presumably has some benefit to him (director's fees, influence over Corp A). It is a somewhat attenuated argument though. The benefitm, though ultimately real because of the purchase by A of pt's property, is indirect. The larger fiduciary issue may be the pt as director involved in A's purchase of the pt's property. There is also the issue of whether the participant is a fiduciary. Have to be a fiduciary to have a prohibited transaction for a conflict of interest. And the 404© rules say - if I remember correctly - that the participant in a self-directed plan that meets 404© is not a fiduciary.

A deemed Roth IRA within a 401(k) plan is possible, but why would a 401(k) plan sponsor want it or allow it? If the owner or an employee wants a Roth IRA, he or she should simply set one up outside the plan. Adding it to the 401(k) Plan is too complicated and will be regretted. On the other hand a Roth contribution to a 401(k) plan makes sense - because the owner gets the benefit even if he weren't eligible for a Roth IRA. However, a Roth contribution to a 401(k) plan is subject to the same rules as elective contributions, and that is what the 401(k) regs are all about.

The only choices are 457(b) - eligible 457 plan, or 457(f) - ineligible 457 plan. The way it works, if it is deferred compensation and it meets 457(b) it is taxed one way (favorably), and if it is deferred compensation and it doesn't meet 457(b), it is taxed under 457(f) (not as favorably, but still some possibilities). The alternative is a taxable benefit - cash, a taxable annuity, or life insurance are the common alternatives. With the limits of 457, the new 409A rules that apply to 457(f) arrangements, and historically low tax rates, cash doesn't look that bad.

A partnership with only highly compensated employees partners (and no employees) allowed the partners to set up their own SEPs and contribute whatever they wanted within IRS limits. Some made contributions, some didn't. This violates the SEP rule that requires that all employees (includes partners for this purpose) of an employer (the partnership) must receive the same level of contributions (as a percentage of pay). Question: The normal way to correct this would be for the parnership to contribute amounts (and make up earnings) for each partner so that all received the same contribution as a percentage of pay. But this bothers me because the partners are all highly compensated and self-employed - it doesn't make sense because the make up contributions will be made in a later year, reducing the partners' income in the later year, and the deduction will go to the partners who got the additional contribution. It seems useless to correct this way, not to mention the fact that it will make the partners who didn't have SEPs before unhappy. Is there an argument that it would be ok not to do any sort of correction, other than to lay out procedures to ensure that it will never happen again? Or, what about the partners who got contributions simply taking distributions? Is there an argument that this will correct so they don't have to change their tax returns? Could you argue that the distribution is not subject to the early withdrawal penalty or the penalty on excess contributions to an IRA because the distribution was a correction? Any suggestions?

KJohnson - I think the seed money idea complicates the asset accounting unnecessarily and should be avoided because: 1. The documentation for the seed money - "it's a loan but it's exempt, it's not an asset that is to be allocated, it's not a suspense account, etc." - will be more expensive than just paying the bank fees. It is much cleaner not to have these issues. 2. You still have the issues with loans and reimbursement of expenses paid by the company. I'm not convinced that this works under the rules. I could be wrong, but I'm an experienced person and my doubts are reasonable. Why have this sort of issue that must be explained to the IRS or DOL or participants if it is ever reviewed? In my experience asset issues are the first ones that a DOL auditor reviews - and if he or she sees a suspense fund like this, it is an issue. 3. The Plan has to account for this seed money every year. This would be another quirk in administration that has to be explained to everyone who works with the plan every year. 4. Why doesn't the employer just pay the bank fees? 5. IMO - Brokerage houses that don't have a reasonable way to handle payments should not be given the business. L.

You'd want to start with the eligible plan to the extent of the limits because you avoid the deferred compensation/constructive receipt issues - it makes it much easier for the executive to have a 457(b) benefit. If that isn't enough, you would add on top of that the 457(f) plan. But as you can tell from the posts on this topic, there are many questions about how these will work with ss 409A. To be safe I think you'd have to have a substantial risk of forfeiture that meets ss 83 standards - basically a real risk of forfeiture conditioned on continued employment - no vesting contingent on bogus consulting agreements or noncompetes, or rolling forfeitures. But you should probably wait like everyone else for additional guidance on 409A and 457.

SpuddyMom - what kind of name is that? The problem I see with your solution is that the executive currently has the right to payment without the delay, and the company's unilateral amendment of the arrangement would not really bind the executive. Or if the executive waives the right to demand early payment, that is the same as an election to delay, and you're back to the 5 year rule. L.

mbozek - I know that's what the IRS is saying, but I don't understand its reasoning. Doesn't the fact that if you don't work the whole period you get $0 mean that you are getting a materially greater amount if you do work the entire period. It just doesn't seem like a very good concept - lots of loopholes and ambiguity. Why complicate the substantial risk of forfeiture concept? Locust

You might do something similar to rolling vesting, which would be to accept taxation and payment of the current ineligible arrangement in 2006, but defer other 2006 income (election made before 2006) to a later period. Of course, you'd have to put a substantial risk of forfeiture on the new deferral to avoid taxation, which may be unpalatable. But this approach raises the issue of whether the IRS will accept a substantial risk of forfeiture on salary reduction amounts. Q/A 10 of 2005-1 - says the IRS won't recognize as legitimate a vesting condition on salary reduction compensation - "a salary deferral generally may not be made subject to a substantial risk of forfeiture." We need more guidance.

E - That's an interesting point. The way I am thinking it may go is that once the benefit is vested, it is taxed, so 409A won't apply to that part of the benefit. The issue under 409A might be the earnings after the benefit is vested, which are taxed when paid or made available. I'm hoping we'll get a pass from the IRS on the earnings, so that when the benefit is vested, the employee would be able to defer payment at that point under rules similar to 457(b). This makes sense to me but I have no statutory basis for this, other than that it makes sense. L

Rolling Vesting - At least one well-known benefit professional has written that rolling vesting will still be allowed for 457(f) arrangements because the "substantial risk of forfeiture" standard under 457 (b) will be different from the standard under ss 83(b) and 409A. [There is not an explanation of why it should be different.] But then I saw an article from a national benefits consulting firm that seemed to say that not only will rolling vesting not be allowed for 457(b) arrangements under the new rules, but that the IRS was actively auditing old 457(f) arrangements and finding the rolling vesting to be per se bogus. Anybody heard of IRS audits of this issue? Any update from the IRS? One of the arrangements I'm working on now has rolling vesting. I'm thinking of leaving it in there for now. It seems to me that there are so many rolling vesting provisions out there that the IRS will be forced to provide some transtional relief, even if it disapproves of the concept.

I hadn't thought of the obvious answer. A more straightforward approach if the individual doesn't want to go through the hoops of going back to the partnership. The IRS allows the withdrawal of contributions without penalty if it is done by the tax return deadline. Earnings have to be taken too - those are taxable and I believe those are subject to the 10% premature payment tax. Code ss 408(d)

If the money stays in there, it will definitely be an excess contribution. I'd get the IRA custodian to make a refund of the entire amount to the partnership, and then have the partnership reissue the check to the proper account. And let the IRA custodian know that the payment to it was a mistake and not to report it as a contribution. I'm not sure what you would do with any earnings attributable to the amount while it was in the IRA. Perhaps those could stay in the IRA and be characterized as a contribution for 2005, but that would be a reporting mess because the individual would have to report the earnings as income and the IRA custodian probably wouldn't report the earnings as a contribution. Or perhaps the earnings could be withdrawn and reported as taxable distributions and pay the penalty for early withdrawal. Or perhaps the earnings could also be distributed to the partnership (if it will accept them). The earnings issue is difficult, but maybe there weren't any?

Mark W - I think you're saying that the benefit of the COLI owned by the employee vs. regular life insurance is that the COLI is cheaper. Why is COLI cheaper than regular life insurance? What kind of percentage discount does COLI get over regular life insurance?

Some NQDC plans say the employer has no obligation to fund the benefits through a rabbi trust or otherwise. If this is the case, you wouldn't have to do anything. If the NQDC plan obligates the employer to fund through a rabbi trust, there would be a contractual obligtion on the part of the employer to do so. A unilateral change of the contract generally wouldn't be allowed, but you'd have to look at the NQDC plan (the contract) to see what it says. I've seen some weird ones that say first, that the employer is obligated to do something, but that second, the employer can unilaterally amend the contract.

The difficult issue is finding out what executive compensation arrangements are out there and how they should be valued. For example, executives might have stock options, split dollar plans, retiree medical, change of control agrements, and SERPs that they and the company minimally value for some purposes (namely tax and financial reporting purposes), and they will give you that value in responding to a spouse's attorney, but that have much greater value. For example, a SERP might provide for a benefit of 100% of final pay, offset by other benefits, with cost of living increases after retirement and retiree medical. Obviously, this is a benefit of tremendous value, but because it is hard to value and often extensively reported, the executive will tend to minimize the value. It is important to get all executive agreements, to review insurance documents, rabbi trusts and asset reports on those assets, and to review SEC disclosures if available. It may be necessary to get depositions from the Compensation committee or others with the information. Under state law the spouse may not be able to get a piece of all of these, but it is important to get the information so that the spouse (and if it goes to court, the court) will have the full financial picture.

This is an unusual situation and I would appreciate feedback. A company has a medical reimbursement plan that limits reimbursements to medical expenses for treatment of on-the-job injuries that are not reimbursable by workers compensation. Without going into specifics, this is an unusual company and the injuries are regularly incurred and are not the result of accidents - for example, ankle injuries for a basketball player. If this were a medical plan for a basketball team, the players would be reimbursed for ankle braces, the orthopaedist, and massage therapy. The question is what to do when the employee quits. I don't think this should be subject to COBRA because it is limited to on-the-job injuries, and non-employees wouldn't have on-the-job injuries. Any guidance out there on this issue? Locust

Yes. I see that for TRA '86 the IRS specifically stated that the extended amendment dates applied to what I would call "non-legislative" governmental entities. For example: FINAL-REG §1.401(k)-1. Certain cash or deferred arrangements For purposes of this paragraph (b)(1), the term governing body with authority to amend the plan means the legislature, board, commission, council, or other governing body with authority to amend the plan. Notice 2005-5 isn't that specific, but I agree that the extended compliance date was probably supposed to apply to "non-legislative" governmental entities. Thanks

The earnings on the account when it becomes vested are taxed, but the earnings thereafter are not taxed until paid or "made available." Example: year 1 - contribution of $8,000. Year 3 - account of $10,000 (that includes $8,000 contribution and earnings on contributions through year 3) is vested. Payment of that account occurs in year 5, when the account is worth $12,000. Result: Year 3 - taxed on $10,000, year 4 - taxed on $0, and year 5 - taxed on $2,000. Is it possible that if you elected in year 4 to delay payment from year 5 until year 8 that you'd have a 409A issue on the income part of the account (income after year 3)? It looks that way to me - the earnings are taxable when made available, which is the constructive receipt standard, and the way I am thinking 409A works, 409A is now the standard for constructive receipt.

Mbozek - thanks very much for looking at and replying to my post. I believe that the 6 month restriction on payments applies only to key employees of publicly traded companies. The other restrictions in 409A that you mention would not seem to be common for nonprofit or governmental employers. Would you agree that the only significant changes of 409A would seem to be the timing of deferrals and the elimination of rolling vesting (and possibly other substantial risk of forfeiture "schemes")? Oops - I hadn't thought about the deferral of the taxation of earnings under 457(f). What would be the effect of a 457(f) plan provision that allowed an executive to defer payment of an amount that is already vested? For example, 100% vested if still employed on 12/31/2006, but with the right to defer payment until 2008? Is this an impermissable deferral of the earnings from 1/1/2007 to 2008?

You should be ok. The rules say you can file under DFVC until the plan administrator receives a written request for the delinquent 5500. See http://www.dol.gov/ebsa/faqs/faq_dfvc.html Who is eligible to participate in the DFVC Program? Plan administrators are eligible to pay reduced civil penalties under the program if the required filings under the DFVC Program are made prior to the date on which the administrator is notified in writing by the Department of a failure to file a timely annual report under Title I of the Employee Retirement Security Act of 1974 (ERISA).