EGTRRA Violates California 457 Law?

[Guest KCW]

According to its report posted at http://www.icmarc.org/retirementreform/cal457.html, ICMA Corp. is of the opinion that employers should wait until California tax law is updated before implementing EGTRRA's higher ($11k/$12k vs. $8.5k) 457 limits, "taxable when received" provisions, and 457-to-qualified plan rollovers.

According to ICMA, California law could consider any 2002 457 deferrals over the 2001 $8,500 limit (adjusted for inflation) to be excess contributions for California state income tax purposes.

According to ICMA, under state law, EGTRRA rollovers from a 457 plan to a non-457 plan could be a taxable distribution, and under state law participants may not be able to change their benefit payment schedules. (It seems California law still applies the pre-EGTRRA "constructive receipt"/"taxable when made available" concept instead of EGTRRA's "taxable when received" recognition model.)

According to ICMA, current California law does not prohibit a state and local governmental 457 plan from implementing EGTRRA, but doing so could have a negative impact on its participants' California state income tax liability.

ICMA says it is likely that in early 2002 the California legislature will modify state tax law to conform to EGTRRA, retroactive to 1/1/2002. ICMA encourages employers to urge our elected state representatives and the Governor to resolve this matter as swiftly as possible.

[MGB]

This is not just California.

Many states will produce problems with all of EGTRRA, not just 457. In particular, Massachusetts is a major problem because their laws do not conform to EGTRRA.

[Guest shafter]

I have expressed concern over this issue on a thread about catch contributions, but no one else seems concerned. According to one of our attorneys: "The State of California has not yet adopted conforming EGTRRA legislation. While this is not unusual, as the state often adopts conforming tax legislation late, it appears there is a good deal of discussion going on that some or all of the benefit provisions in EGTRRA may not be adopted because of the state's financial problems. California is not the only state is this situation." I hope this thread does not go unnoticed because of the Board it was posted to.

[Carol V. Calhoun]

I think a lot of states are going to want to pass legislation reflecting EGTRRA. The problems include the one you mentioned, plus laws limiting rollovers to amounts derived from other plans of the same type (e.g., a 401(a) plan might limit rollovers into the plan to those directly or indirectly from another 401(a) plan). In many instances, EGTRRA did not require plans to make changes, but those which do not may discover they are unnecessarily limiting employees' options.

[lkpittman]

We have several public law clients that are asking about this problem. We are taking it up with our local Assemblyman (CA), who is happy to get behind conforming state legislation.

[Guest KCW]

Apparently, the California legislature is serious about enacting tax reforms that fall short of full compliance with EGTRRA.

California's Senate and Assembly Revenue and Taxation Committees are asking for written proposals for specific measures that would bring California into partial conformity with EGTRRA, but would mitigate the revenue loss that would result from full conformity.

The proposals will be presented to a joint meeting of the Senate and Assembly Revenue and Taxation Committees around the second week of January.

Monday, December 17 is the deadline for submissions. (Sorry about the last minute heads up. The original e-mail to me about this issue was obliterated in the recent "Goner" e-mail virus attack, and I just got word of the RFP.)

For more info, go to http://www.pensioninfo.org/2001_12_01_acv.html#7933363, or contact me at EGTRRA@457b.org.

[Guest KCW]

A copy of the ICMA Retirement Corporation's recent response to a request they received from the Chairmen of the California Senate and Assembly Revenue + Taxation Committees.

http://www.pensioninfo.org/ca_comment.html

In the response, ICMA RC's legal counsel provides State Committee members with a detailed review of the impact on employees, employers, and plan recordkeepers should the State elect not to implement all of the changes made available under EGTRRA.

[lkpittman]

Maybe this is a stupid question--but can anyone cite the CA Code Sections that are in conflict with EGTRRA? I've read the articles and other posts, but would like to be able to cite the CA Code Sections that are "non-conforming."

[Mike Preston]

Derrin Watson, who hosts the Who's The Employer? column here, was kind enough to give me permission to quote one of his recent messages that he posted on the Pension Information eXchange (wording slightly changed as to tense):

Perhaps it would help to understand how it is that California, as an example, uses the IRC. California's Revenue & Taxation Code has many sections which directly refer to the Internal Revenue Code. One of those is section 17501 which states:

17501. Subchapter D of Chapter 1 of Subtitle A of the Internal Revenue Code, relating to deferred compensation, shall apply, except as otherwise provided.

In other words, rather than having its own retirement plan provisions, the California tax law simply incorporates the IRC by reference. That takes in sections 401-424. But there's a catch:

17024.5. (a) (1) Unless otherwise specifically provided, the terms "Internal Revenue Code," "Internal Revenue Code of 1954," or "Internal Revenue Code of 1986," for purposes of this part, mean Title 26 of the United States Code, including all amendments thereto as enacted on the specified date for the applicable taxable year as follows:  

[......long list of effective dates removed.  Here's the last in the list]

(L) For taxable years beginning on or after January 1, 1998 .......................... January 1, 1998

In other words, right now California law has incorporated the IRC as it stood 1/1/98. It isn't a matter of choosing to bring in catchups or 25% deductions or not. Right now, EGTRRA has absolutely zero affect on how qualified plans, their sponsors, and their participants are taxed by the state of California. That will remain true unless and until the California legislature acts. They may choose to bring in all or part of EGTRRA. It is likely that they will add a new subsection (M) saying that for taxable years after 2001, the IRC as of 1/1/02 applies. However, they may (probably will) go through and carve out various exceptions.

Where do things stand now in the absence of state action? Well, as was pointed out, a profit sharing plan is limited to a 15% deduction in California, but that's probably the least of our worries.

If you make a catchup contribution, it's just a normal elective deferral as far as California is concerned. It counts for 402(g); it counts for 415; it counts for ADP. Moreover, since 401(a)(30) requires a plan to limit contributions to 402(g), and since 415 requires plans to limit annual additions to 415©, a plan which provides for catchup contributions in accordance with the federal standard is not a qualified plan for California tax purposes. That means the trust is taxable on its earnings, and either the sponsor looses its deduction for contributions or the participants are taxable on their vested accounts.

The same is true of a plan which provides for the $40,000/100% 415© limit. The same is true of a plan which provides for the $160,000 415(B) limit. It doesn't matter whether it provides for the higher limits by adopting an amendment, or whether it incoporated the limits by reference.

Now, of course, this would be a disqualifying provision, and a normal remedial amendment period would apply. Hopefully, the state legislature will get its act together in time to avoid calamity, but that's where we stand right now.

[lkpittman]

Thanks for the information.

Maybe some of you are already aware that proposed legislation was submitted in the Assembly on Monday. Just yesterday, I found AB 1743 and 1744, which are supposed to bring California into federal conformity--although I have not read the proposed bills yet and I've heard that there may not be total conformity. You can find the text of these bills at www.megalaw.com.

[Guest S.Yahiro]

Just so you folks don't feel alone, the State of Hawaii's tax code is also non-conforming to EGTRRA. For our 457 plan we are currently trying to decide what to do. Legislation has been submitted to conform our State tax laws, but our Legislature does not adjourn until late May. Until then, we are considering:

1) Allowing participants to contribute the higher limits after being appropriate informed (via a written disclosure) of the risks (should the State tax code change NOT be approved); 2) Not allowing certain EGTRRA provisions, such as rollovers/transfers into our plan from non-457 plans; 3)QDROs, and a few others. At this time we are also trying to decide if the written disclosure should have the participant's signature acknowledging they were informed.

Does anyone know if any other States who have non-conforming State tax codes/laws are allowing some/all EGTRRA provisions. If so, are they giving written disclosures? If so, are they requiring participants to sign the disclosure?

Aloha!

[Guest KCW]

I don't know of any non-compliant states that have offered any guidance about this, but I do know what three state and local 457(B) TPAs have advised the sponsors they serve.

They advise employers not to amend their plans to accommodate any of the new optional or mandatory EGTRRA provisions until the state addresses the non-compliance issue.

This means using the old 457 rules covering contribution limits, not allowing the 50-year-plus catch up, not allowing service credit purchase with in-service distributions, not allowing rollovers-in to their 457 plans, etc.

However, these TPAs advise employers to ADMINISTER their plans to allow rollovers out of 457(B) plans per EGTRRA, and to use the $1,000 deminimus cashout rule, and any other MANDATORY EGTRRA provisions. (Probably won't find too many takers on the roll-out option among participants in non-compliant states.)

As far as disclosure to participants, the TPAs seem to be playing it pretty close to the vest. I think you will see employers allowing contribution rates that add up to the new EGTRRA limits on the assumption that the state will get in line. They are also leaving last year's controls in place to stop deferrals at the old limits.

If at some point the state amends its laws to comply, fine, the employer amends the plan retroactively to 1/1/02 and cuts over to the new limits.

If the state does not, those employees contributing $423 - $462 per biweekly pay period, will suddenly find their deferrals shut off in pay period 18 or 20 instead of pay period 26.

I have not heard of anyone suggesting that employees be permitted to defer over and above the state limit. That could trigger state de-certification of the entire plan. Besides, no record keeper is set up to deal with contributions that are pre-tax on a federal basis, and after-tax on a state basis.

[Carol V. Calhoun]

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."

[mbozek]

KCW: the larger payroll services provide for different state and federal reporting requirements, e.g., in NJ 403(B) and 125 contributions are not excluded from state income tax but 401(k) contributions are. If the issue is only the state tax deduction why not allow the employees to make contributions over the state limit on an after tax basis so they get the benefit of the federal tax deduction. This way if the law is changed they won't have to make catch up contributions.

Also would a state decertify a public employer who adopts the new limits for a 403(B) annuity plan? If not then public school and university employees could make addditonal contributions to a TSA until the issue is resolved.

[Carol V. Calhoun]

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.

[Guest KCW]

Mbozek: I think you are right. I have come to understand that employers in non-compliant states are doing exactly what you propose.

One of our 457 providers listed possible ways for employers to deal with the state temporary non-compliance issue.

There were two basic philosophies, 1. keep limits at the old levels, and 2. allow participants to defer up to the EGTRRA limits, but issue disclosure statements about the possible tax consequences.

My original post was based on advice that three of our 457 providers issued late last year, before it was relatively certain that California will pass a complete (at least for 457 plans) EGTRRA conformity bill.

Remember, I'm no attorney, so you'll get no original thinking from me--just rumor and hearsay. #8^>

[mbozek]

Mike: Can I ask a stupid question. Aren't state tax laws preempted by ERISA in so far as applying to a qualified plan? They are not within the realm of insurance, banking and securities laws. While the state can tax individual participants by denying an exclusion under state law for contributions in excess of the 1998 limits (this would include participants in a 403(B) plan) I don't see where cal can tax the earnings/accounts held in a qualified plan. The state law as written only limits employer deductions to 15% of covered compensation. Anything over that amt is not deductible under the Cal corp tax.

Stupid Question 2. If the 1998 provisions are effective in 2002 does this mean that allocations/benefits on comp in excess of $170,000 are not deferred under Cal income tax? Therefore Cal residents will have to pay income tax on such amts at a marginal rate of up to 10%. Do cal residents know about this? And who is going to compute this amount and report it to CAl?

[david rigby]

I think Q2 is an answer to Q1. ERISA preempts state laws as they propose to regulate employee benefit plans otherwise covered by ERISA, but it does not preempt state laws which determine income taxable for state purposes.

[Carol V. Calhoun]

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.

[mbozek]

Aren't the 457 plans irrevalent to the issue since the govt employers will limit contributions to the limits under 2001 until legislation is adopted. I think the premise of Q 2 is still valid:are profit making employers going to limit their contributions/accruals to pre 2002 limits in order not to violate Cal st law? I think not. In addition under IRC 414(v) an employer must offer universal availability for catch up contibutions. The question is when are cal employees going to be told about this new taxation and when will cal require withholding of the excess amounts? What will be the reaction of cal. taxpayers in a gubernatorial election year when employees find out about this additional taxation (and when will the employer be required to withhold taxes on these amounts)??. I would like to hear from cal residents on this issue.

[Guest KCW]

California law will comply.

The legislature is just taking its sweet time about it.

See article at http://www.pensioninfo.org/2002_02_01_acv....v.html#10212362

[Mike Preston]

mbozek: I agree with KCW. I believe that California will comply, it is just a matter of time. I am very hopeful that this is not just wishful thinking.

Until they definitively decide not to comply or they definitively comply, everybody speculates. A collosal waste of time, but a necessary one when discussing options with clients.

You are absolutely correct that the 457 issue tekes care of itself because the employers are self-limiting.

In the 401(k) market I see a polarized result set. About 90% of the smaller plans, where administrative fees are a major concern, are not implementing catch-up yet. Giving up on the $1,000 available in 2002 (if it actually comes to that) seems like a small insurance policy against the issues of communicating the potential outcomes to participants and then dealing with those outcomes. Maybe the tide would turn at $2,000 in 2003, but hopefully we'll never have to worry about that.

The larger plans truly believe that there is no way that California won't comply and they have not communicated a single thing about non-conformance. But this is just my small circle of contacts, so for all I know 99% of the larger employers actually have communicated this. Although somehow I doubt it.

[Guest KCW]

Five states originally considered to be noncompliant with EGTRRA are now compliant.

14 states are still noncompliant.

10 states have introduced legislation to enact full compliance.

4 states have not introduced compliance legislation. Of these, two states do not appear to be inclined to comply.

More at http://www.pensioninfo.org/2002_03_01_acv....v.html#75002413

[Guest KCW]

AB 131, Ellen Corbett's bill to allow California's public sector employees take advantage of EGTRRA's 457(B) and 403(B) rollover and pre-tax service credit purchase provisions was passed last week in the Senate, and passed the Assembly Monday, April the 15th on a 70 - 0 vote.

The provisions of AB 131 were originally part of Corbett's comprehensive EGTRRA compliance measure, AB 1744, but were moved out of AB 1744 and into the more mature AB 131 in an effort to put them on the fast-track to passage.

Read more about it here: http://www.pensioninfo.org/2002_04_01_acv....v.html#85015009