IRS Expands Determination Letter Program to Merged Plans and Statutory Hybrid Plans

The IRS has issued Rev. Proc. 2019-20, expanding its determination letter program to allow submissions by individually designed statutory hybrid plans and merged plans. Previously, the determination letter program was limited to applications for initial plan qualification and upon plan termination only. The IRS has indicated it will annually reconsider whether determination letters should be issued in other specified circumstances.

“Statutory hybrid plans” are defined benefit plans that use a hypothetical account balance (for example, a cash-balance plan) or an accumulated percentage of the participant’s final average compensation (for example, a pension equity plan) to establish a participant’s accrued benefit.

“Merged plans” are tax-qualified retirement plans resulting from the merger or consolidation of two or more plans of previously unrelated entities to form a single individually designed plan.

Applications by these plans will be permitted as follows:

Statutory Hybrid Plans. The determination letter program will be opened to statutory hybrid plans only for the 12-month period beginning September 1, 2019, and ending August 31, 2020. These plans will be reviewed for compliance with the 2017 Required Amendments List, and all previous lists.

Merged Plans. The determination letter program will be opened to merged plans on an ongoing basis, beginning September 1, 2019. To obtain a determination letter:

  • the plan merger must occur by the end of the first plan year beginning after the plan year in which the corporate merger, acquisition, or similar business transaction occurred; and
  • the application must be submitted during the period beginning on the date of the plan merger and ending on the last day of the first plan year beginning after the plan merger.

Merged plans will be reviewed based on the Required Amendments List issued during the second full calendar year before the submission, and all previous lists (including Cumulative Lists).

Any remedial amendment period that is open at the start of one of the submission periods described above will stay open until the end of the submission period. Plans will also get the benefit of the usual rule extending the remedial amendment period for a submitted plan until 91 days after a determination letter is issued.

Comment and Implications

For plan sponsors involved in corporate mergers, the provisions in Rev. Proc. 2019-20 will be particularly helpful. Determination letters protect against IRS challenges to plan provisions disclosed in a determination letter application. That protection can be especially important when an employer merges its own plan (which the employer may be reasonably confident meets the qualification requirements) with the plan of a previously unrelated employer. The 2016 changes to the determination letter program left many employers unable to request letters in that situation, increasing the risk of plan mergers. This concern can now be addressed through a determination letter application.

Sponsors of already-merged plans should also determine whether they can still submit a determination letter application. The September 1, 2019, opening date does not appear to preclude submissions of plan mergers that occurred before that date, as long as the applicable criteria are met.

IRS Expands Self-Correction Program

The IRS recently published Revenue Procedure 2019-19, which makes significant improvements to the Employee Plans Compliance Resolution System (“EPCRS”) corrections procedure for qualified retirement plans.

The updated EPCRS correction procedure comes after the IRS made other changes last year, which require correction applications to be filed electronically as of April 1, 2019. The updated EPCRS provides new ways that Plan Sponsors can self-correct Plan errors without having to file a formal correction with the IRS. This means more ways to correct without having to tell the IRS about the failure and without having to pay the voluntary Correction Program (VCP) fees.

What’s New?

The new procedure permits plans to self-correct failures occurring in two broad categories that previously required VCP filings: problems with participant loans and plan amendments.

Loan Failures

Generally, when a participant fails to repay his loan on time, the total principal and accrued interest of the loan becomes taxable income to the participant in the year of default, or after the end of a short “grace period” after the default. Previously, once that grace period had ended without repayment, a formal VCP application was the only way to prevent the full taxation, even if the failure occurred because the plan sponsor failed to start the intended automatic deduction for the loan repayment on its payroll system.

The new correction procedure allows self-correction of loan failures if the failure relates to:

  • A default on loan payments (if the five-year maximum repayment period has not expired);
  • Allowing participants to have multiple loans even though not permitted under the plan or loan procedure;
  • Providing a loan when the plan does not permit loans; or
  • The failure to obtain spousal consent (assuming that the spouse is now willing to provide that consent—if not, VCP is required to repair this failure).

If a defaulted loan is self-corrected under the new procedure, the loan is not treated as taxable income to the Participant. This new ability to self-correct these failures and avoid the tax consequences is a significant improvement to the EPCRS options. If the loan default happened so long ago that the maximum five-year repayment period has already expired, the self-correction program may still be used to allow the income to be taxable in the year of correction, rather than the year of default.

Two other loan failures listed above—providing loans when the plan does not permit them or failing to limit the number of loans a participant takes—would not produce taxable income to the participant, but could threaten the tax qualification of the plan. This problem can now be corrected through self-correction using a retroactive plan amendment.

Note: self correction is still not an option if a plan sponsor allows participants to take loans in amounts that exceed the legal limits (generally, $50,000 or 50% of the participant’s vested account), loans that have repayment periods in excess of the five-year limit (or the extended period allowed for home loans), or loans that do not provide for level, fully amortized payments. Such failures must still be corrected through a VCP application.

While the IRS considers loans corrected under VCP to be fully corrected for ERISA purposes, the Department of Labor (“DOL”) does not give that same deference to self-correction under EPCRS. Therefore, if the plan sponsor or participant wants to be sure that the loan does not represent a prohibited transaction or that excise taxes are not accruing, a separate filing under the DOL’s Voluntary Fiduciary Correction Program may be required.

Amendment Failures

Historically, most failures to amend a plan had to be corrected by filing a formal VCP application. There were three exceptions, all relating to operating the plan not in accordance with the plan provisions. These exceptions included:

  • allowing participants to enter the plan too soon (correct by amending the plan so that the eligibility requirements match what was already done);
  • allowing participants to take loans or hardship distributions where the plan did not permit those distributions (correct by amending the plan to permit loans or hardship distributions); and
  • failure to limit the compensation used for contribution allocations to the legal limit ($280,000 for 2019) (correct by amending the plan to increase the contribution for everyone to the amount needed to justify the allocation given to the highly paid person, when applying the compensation limit).

The new procedure allows self-correction by amendment in more situations.

Amendments to Match the Plan to Actual Operations or Late Adoption of Discretionary Amendments

Amendments may now be made to correct operational errors where the plan has been administered differently than the document provides or to correct the failure to timely adopt a discretionary amendment, if:

  • The amendment conforms the plan document to actual operations;
  • A benefit, right, or feature of the plan would increase as a result of the amendment;
  • The increase applies to all eligible employees; and
  • Providing the increase is consistent with the EPCRS correction principles.

Amendments to Cure Plan Document Failures

Amendments may also be used to self-correct plan documentation failures (i.e., failures relating to the inclusion of a provision that is prohibited or the omission of a provision required for plan qualification):

  • If the failure is a so-called “nonamender failure,” i.e., a failure to timely amend the plan. This includes a failure to timely adopt an interim amendment required by the IRS.
  • If the failure is that the sponsor of an individually designed plan (“IDP”) did not timely adopt an amendment needed to comply with an item that appeared on the Required Amendments List. Generally, the sponsor of an IDP must adopt such an amendment by the end of the second calendar year after the item first appears on the Required Amendments List.

Note: All corrections by amendment are significant failures. This means that, to self-correct these issues, the correction must be completed before the end of the second year following the year in which the error occurred.  

IRS Announces COLA Adjusted Retirement Plan Limitations for 2019

The Internal Revenue Service today released Notice 2018-83 announcing cost of living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2019.

Highlights Affecting Plan Sponsors of Qualified Plans for 2019

  • The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from  $18,500 to $19,000. The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan remains unchanged at $6,000.
  • The limit on annual contributions to an IRA, which last increased in 2013, is increased from $5,500 to $6,000. The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.
  • The limitation on the annual benefit under a defined benefit plan under Section 415(b)(1)(A) is increased from $220,000 to $225,000.
  • The limitation for defined contribution plans under Section 415(c)(1)(A) is increased in 2019 from $55,000 to $56,000.
  • The annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $275,000 to $280,000.
  • The dollar limitation under Section 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $175,000 to $180,000.
  • The dollar amount under Section 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a five year distribution period is increased from $1,105,000 to $1,130,000, while the dollar amount used to determine the lengthening of the five year distribution period is increased from $220,000 to $225,000.
  • The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) is increased from $120,000 to $125,000.
  • The limitation under Section 408(p)(2)(E) regarding SIMPLE retirement accounts is increased from $12,500 to $13,000.

The IRS previously Updated Health Savings Account limits for 2019. See our post here.

The following chart summarizes various significant benefit Plan limits for 2017 through 2019:

Type of Limitation 2019 2018 2017
415 Defined Benefit Plans $225,000 $220,000 $215,000
415 Defined Contribution Plans $56,000 $55,000 $54,000
Defined Contribution Elective Deferrals $19,000 $18,500 $18,000
Defined Contribution Catch-Up Deferrals $6,000 $6,000 $6,000
SIMPLE Employee Deferrals $13,000 $12,500 $12,500
SIMPLE Catch-Up Deferrals $3,000 $3,000 $3,000
Annual Compensation Limit $280,000 $275,000 $270,000
SEP Minimum Compensation $600 $600 $600
SEP Annual Compensation Limit $280,000 $275,000 $270,000
Highly Compensated $125,000 $120,000 $120,000
Key Employee (Officer) $180,000 $175,000 $175,000
Income Subject To Social Security Tax  (FICA) $132,900 $128,400 $127,200
Social Security (FICA) Tax For ER & EE (each pays) 6.20% 6.20% 6.20%
Social Security (Med. HI) Tax For ERs & EEs (each pays) 1.45% 1.45% 1.45%
SECA (FICA Portion) for Self-Employed 12.40% 12.40% 12.40%
SECA (Med. HI Portion) For Self-Employed 2.9% 2.9% 2.9%
IRA Contribution $6,000 $5,500 $5,500
IRA Catch-Up Contribution $1,000 $1,000 $1,000
HSA Max. Contributions Single/Family Coverage $3,500/ $7,000 $3,450/ $6,900 $3,400/ $6,750
HSA Catchup Contributions $1,000 $1,000 $1,000
HSA Min. Annual Deductible Single/Family $1,350/ $2,700 $1,350/ $2,700 $1,300/ $2,600
HSA Max. Out Of Pocket Single/Family $6,750/ $13,500 $6,650/ $13,300 $6,550/ $13,100

ERISA Benefits Law Receives Recognition as a Top Tier Law firm in 2018 U.S. News – Best Lawyers® “Best Law Firms” Rankings

We are happy to announce that ERISA Benefits Law has again been recognized as a top tier law firm in the 2018 U.S. News – Best Lawyers® “Best Law Firms” rankings. The firm received a Tier 1 metropolitan ranking in Tucson, Arizona in Employee Benefits (ERISA) Law. We are grateful for the recognition of our peers, and the trust of our clients, as a niche ERISA and employee benefits law firm focused on providing the highest quality legal services at the most affordable rates anywhere.

The U.S. News – Best Lawyers “Best Law Firms” rankings are based on a rigorous evaluation process that includes the collection of client and lawyer evaluations, peer review from leading attorneys in their field, and review of additional information provided by law firms as part of the formal submission process.

Attorney Erwin Kratz Named to the Best Lawyers in America© 2019

ERISA Benefits Law attorney Erwin Kratz was recently selected by his peers for inclusion in The Best Lawyers in America© 2019 in the practice area of Employee Benefits (ERISA) Law. Mr. Kratz has been continuously listed on The Best Lawyers in America list since 2010.

Since it was first published in 1983, Best Lawyers® has become universally regarded as the definitive guide to legal excellence. Best Lawyers lists are compiled based on an exhaustive peer-review evaluation. Lawyers are not required or allowed to pay a fee to be listed; therefore inclusion in Best Lawyers is considered a singular honor. Corporate Counsel magazine has called Best Lawyers “the most respected referral list of attorneys in practice.”

Treasury and IRS Issue Final Regulations Amending the Definition of Qualified Matching Contributions and Qualified Nonelective Contributions

The Treasury and IRS have issued final regulations amending the definitions of qualified matching contributions (QMACs) and qualified nonelective contributions (QNECs) under regulations regarding certain qualified retirement plans that contain cash or deferred arrangements under section 401(k) or that provide for matching contributions or employee contributions under section 401(m).

Under these new regulations, an employer contribution to a plan may be a QMAC or QNEC if it satisfies applicable nonforfeitability requirements and distribution limitations at the time it is allocated to a participant’s account, but need not meet these requirements or limitations when it is contributed to the plan.

History

On January 18, 2017, the Treasury Department and the IRS issued a notice of proposed rulemaking. Several comments on the proposed rules were submitted, and, after consideration of all the comments, the final rules adopt the proposed rules without substantive modification. However, the Treasury Department and the IRS determined that the distribution requirements referred to in the existing definitions of QMACs and QNECs in §§ 1.401(k)-6 and 1.401(m)-5 are more appropriately characterized as distribution limitations (consistent with the heading of § 1.401(k)-1(d)), and, accordingly, these definitions have been amended to refer to distribution limitations.

Implications of the New Rules

The new rule raises some questions relating to the application of Code section 411(d)(6) (protected benefits) in cases in which a plan sponsor seeks to amend its plan to apply the new rules. The application of section 411(d)(6) is generally outside the scope of these regulations. However, the IRS indicates in the discussion of the new rules that if a plan sponsor adopts a plan amendment to define QMACs and QNECs in a manner consistent with the final regulations and applies that amendment prospectively to future plan years, section 411(d)(6) would not be implicated.

In addition, in the common case of a plan that provides that forfeitures will be used to pay plan expenses incurred during a plan year and that any remaining forfeitures in the plan at the end of the plan year will be allocated pursuant to a specified formula among active participants who have completed a specified number of hours of service during the plan year, section 411(d)(6) would not prohibit a plan amendment adopted before the end of the plan year that permits the use of forfeitures to fund QMACs and QNECs (even if, at the time of the amendment, one or more participants had already completed the specified number of hours of service). This is because all conditions for receiving an allocation will not have been satisfied at the time of the amendment, since one of the conditions for receiving an allocation is that plan expenses at the end of the plan year are less than the amount of forfeitures. See § 1.411(d)-4, Q&A-1(d)(8) (features that are not section 411(d)(6) protected benefits include “[t]he allocation dates for contributions, forfeitures, and earnings, the time for making contributions (but not the conditions for receiving an allocation of contributions or forfeitures for a plan year after such conditions have been satisfied), and the valuation dates for account balances”).

Statutory Background

Section 401(k)(1) provides that a profit-sharing or stock bonus plan, a pre-ERISA money purchase plan, or a rural cooperative plan will not be considered as failing to satisfy the requirements of section 401(a) merely because the plan includes a qualified cash or deferred arrangement (CODA). To be considered a qualified CODA, a plan must satisfy several requirements, including: (i) Under section 401(k)(2)(B), amounts held by the plan’s trust that are attributable to employer contributions made pursuant to an employee’s election must satisfy certain distribution limitations; (ii) under section 401(k)(2)(C), an employee’s right to such employer contributions must be nonforfeitable; and (iii) under section 401(k)(3), such employer contributions must satisfy certain nondiscrimination requirements.

Under section 401(k)(3)(D)(ii), the employer contributions taken into account for purposes of applying the nondiscrimination requirements may, under such rules as the Secretary may provide and at the election of the employer, include matching contributions within the meaning of section 401(m)(4)(A) that meet the distribution limitations and nonforfeitability requirements of section 401(k)(2)(B) and (C) (also referred to as qualified matching contributions or QMACs) and qualified nonelective contributions within the meaning of section 401(m)(4)(C) (QNECs). Under section 401(m)(4)(C), a QNEC is an employer contribution, other than a matching contribution, with respect to which the distribution limitations and nonforfeitability requirements of section 401(k)(2)(B) and (C) are met.

Under § 1.401(k)-1(b)(1)(ii), a CODA satisfies the applicable nondiscrimination requirements if it satisfies the actual deferral percentage (ADP) test of section 401(k)(3), described in § 1.401(k)-2. The ADP test limits the disparity permitted between the percentage of compensation made as employer contributions to the plan for a plan year on behalf of eligible highly compensated employees and the percentage of compensation made as employer contributions on behalf of eligible nonhighly compensated employees. If the ADP test limits are exceeded, the employer must take corrective action to ensure that the limits are met. In determining the amount of employer contributions made on behalf of an eligible employee, employers are allowed to take into account certain QMACs and QNECs made on behalf of the employee by the employer.

In lieu of applying the ADP test, an employer may choose to design its plan to satisfy an ADP safe harbor, including the ADP safe harbor provisions of section 401(k)(12), described in § 1.401(k)-3. Under § 1.401(k)-3, a plan satisfies the ADP safe harbor provisions of section 401(k)(12) if, among other things, it satisfies certain contribution requirements. With respect to the safe harbor under section 401(k)(12), an employer may choose to satisfy the contribution requirement by providing a certain level of QMACs or QNECs to eligible nonhighly compensated employees under the plan.

A defined contribution plan that provides for matching or employee after-tax contributions must satisfy the nondiscrimination requirements under section 401(m) with respect to those contributions for each plan year. Under § 1.401(m)-1(b)(1), the matching contributions and employee contributions under a plan satisfy the nondiscrimination requirements for a plan year if the plan satisfies the actual contribution percentage (ACP) test of section 401(m)(2) described in § 1.401(m)-2.

The ACP test limits the disparity permitted between the percentage of compensation made as matching contributions and after-tax employee contributions for or by eligible highly compensated employees under the plan and the percentage of compensation made as matching contributions and after-tax employee contributions for or by eligible nonhighly compensated employees under the plan. If the ACP test limits are exceeded, the employer must take corrective action to ensure that the limits are met. In determining the amount of employer contributions made on behalf of an eligible employee, employers are allowed to take into account certain QNECs made on behalf of the employee by the employer. Employers must also take into account QMACs made on behalf of the employee by the employer unless an exclusion applies (including an exclusion for Start Printed Page 34470QMACs that are taken into account under the ADP test).

If an employer designs its plan to satisfy the ADP safe harbor of section 401(k)(12), it may avoid performing the ACP test with respect to matching contributions under the plan, as long as the additional requirements of the ACP safe harbor of section 401(m)(11) are met.

As previously defined in § 1.401(k)-6, QMACs and QNECs must satisfy the nonforfeitability requirements of § 1.401(k)-1(c) and the distribution limitations of § 1.401(k)-1(d) “when they are contributed to the plan.” Similarly, under the independent definitions in § 1.401(m)-5, QMACs and QNECs must satisfy the nonforfeitability requirements of § 1.401(k)-1(c) and the distribution limitations of § 1.401(k)-1(d) “at the time the contribution is made.” In general, contributions satisfy the nonforfeitability requirements of § 1.401(k)-1(c) if they are immediately nonforfeitable within the meaning of section 411, and contributions satisfy the distribution limitations of § 1.401(k)-1(d) if they may not be distributed before the employee’s death, disability, severance from employment, attainment of age 59.5, or hardship, or upon the termination of the plan.

Background to the Rule Change

Before 2017, the Treasury Department and the IRS received comments with respect to the definitions of QMACs and QNECs in §§ 1.401(k)-6 and 1.401(m)-5. In particular, commenters asserted that employer contributions should qualify as QMACs and QNECs as long as they satisfy applicable nonforfeitability requirements at the time they are allocated to participants’ accounts, rather than when they are first contributed to the plan. Commenters pointed out that interpreting sections 401(k)(3)(D)(ii) and 401(m)(4)(C) to require satisfaction of applicable nonforfeitability requirements at the time amounts are first contributed to the plan would preclude plan sponsors with plans that permit the use of amounts in plan forfeiture accounts to offset future employer contributions under the plan from applying such amounts to fund QMACs and QNECs. This is because the amounts would have been allocated to the forfeiture accounts only after a participant incurred a forfeiture of benefits and, thus, generally would have been subject to a vesting schedule when they were first contributed to the plan. Commenters requested that QMAC and QNEC requirements not be interpreted to prevent the use of plan forfeitures to fund QMACs and QNECs. The commenters urged that the nonforfeitability requirements under § 1.401(k)-6 should apply when QMACs and QNECs are allocated to participants’ accounts and not when the contributions are first made to the plan.

In considering the comments, the Treasury Department and the IRS took into account that the nonforfeitability requirements applicable to QMACs and QNECs are intended to ensure that QMACs and QNECS provide nonforfeitable benefits for the participants who receive them. In accordance with that purpose, the Treasury Department and the IRS concluded that it is sufficient to require that amounts allocated to participants’ accounts as QMACs and QNECs be nonforfeitable at the time they are allocated to participants’ accounts, rather than when such contributions are made to the plan.

The Final Rules

PBGC’s Expanded Missing Participant Program Final Rule Covers DC Plans and non-PBGC Insured DB Plans

As authorized by the Pension Protection Act of 2006 (PPA), the Pension and  Benefit Guarantee Corporation (PBGC) has issued a final regulation that expands PBGC’s missing participants program, effective as of plan terminations that occur on or after January 1, 2018. PBGC’s missing participant program was previously limited to terminated single-employer DB plans covered by title IV’s insurance program. It is now available to other terminated retirement plans.

Summary of How the PBGC MIssing Participant Program Applies to Defined Contribution (DC) Plans and non-PBGC Defined Benefit Plans

The revised program now provides that PBGC’s missing participants program is voluntary for terminated non-PBGC-insured plans, e.g.,DC plans.

In addition, a non-PBGC-insured plan that chooses to use the program may elect to be a “transferring plan” or a “notifying plan.” A transferring plan sends the benefit amounts of missing distributees to PBGC’s missing participants program. A notifying plan informs PBGC of the disposition of the benefits of one or more of its missing distributees. Section 4050(d)(1) of ERISA permits but does not require non-PBGC-insured plans covered by the program to turn missing participants’ benefits over to PBGC.

A DC plan that chooses to participate in the missing participants program and elects to be a transferring plan must transfer the benefits of all its missing participants into the missing participants program. PBGC explains that this is to prevent the possibility of “cherry-picking”—that is, selective use of the missing participants program—by transferring plans.

PBGC will charge a one-time $35 fee per missing distributee, payable when benefit transfer amounts are paid to PBGC. There will be no charge for amounts transferred to PBGC of $250 or less. There will be no charge for plans that only send to PBGC information about where benefits are held (such as in an IRA or under an annuity contract). Fees will be set forth in the program’s forms and instructions.

The program definition of “missing” for DC plans follows Department of Labor regulations, which treat DC plan distributees who cannot be found following a diligent search similar to distributees whose whereabouts are known but who do not elect a form of distribution.

A distributee is treated as missing if, upon close-out, the distributee does not accept a lump sum distribution made in accordance with the terms of the plan and, if applicable, any election made by the distributee. For example, if a check issued pursuant to a distributee’s election of a lump sum remains uncashed after the last date prescribed on the check or an accompanying notice (e.g., by the bank or the plan) for cashing it (the “cash-by” date), the distributee is considered not to have accepted the lump sum.

A DC plan must search for each missing distributee whose location the plan does not know with reasonable certainty. The plan must search in accordance with regulations and other applicable guidance issued by the Secretary of Labor under section 404 of ERISA. See the DOL’s FAB 2014-01 for guidance on search steps. Compliance with that guidance satisfies PBGC’s “diligent search” standard for DC plans.

Some other major features of the new program include:

  • A unified unclaimed pension database of information about missing participants and their benefits from terminated DB and DC plans.
  •  A centralized, reliable, easy-to-use directory through which persons who may be owed retirement benefits from DB or DC plans could find out whether benefits are being held for them.
  • Periodic active searches by PBGC for missing participants.
  • Fewer benefit categories and fewer sets of actuarial assumptions for DB plans determining the amount to transfer to PBGC and a free on-line calculator to do certain actuarial calculations.

Visit the PBGC’s Missing Participant site for more information, including an  explanation of the plans covered by the program and the forms and instructions to use with the program.

Our prior post on the proposed regulations is here

Private Letter Ruling Applies Controlled Group Rules to 501(c)(3) Entities

On March 16, 2018 the IRS issued a private letter ruling (PLR 201811009) analyzing and applying the controlled group rules to two related 501(c)(3) entities. The first entity is a Medical Center, organized in part for the purpose of operating an academic medical center as part of a health system affiliated with the other entity, a University.

The PLR reiterates the general rule that one 501(c)(3) entity (the University) in this case) does not “Control” another 501(c)(3) entity (the Medical Center) for purposes of the IRS controlled group rules where:

  • The University holds the power to approve and remove without cause four of the Medical Center’s 11 directors.
  • With the exception of the University’s chancellor, no employee of the University may serve as a director of the Medical Center.
  • The University holds no right or power to require the use of the Medical Center’s funds or assets for the University’s purposes.
  • Rather, the Medical Center determines its budget, issues debt and expends funds without oversight from the University.
  • The Medical Center has sole control over collection of its receivables and sole responsibility for satisfaction of its liabilities.
  • The University does not control hiring, firing or salaries of the Medical Center’s Employees.

The PLR states that the above facts evidence the Medical Center’s operational independence from the University and support a conclusion that the University does not directly control the Medical Center.

The PLR goes on to conclude that the University does not directly control the Medical Center, even though the University has the right to prohibit the Medical Center from taking certain actions, including:

  • any major corporate transaction not within the ordinary course of business;
  • any action that would result in a change in the Medical Center’s exempt status under §§ 501(c)(3) and 509(a) of the Code;
  • any material change to the Medical Center’s purposes;
  • any change in the fundamental, nonprofit, charitable, tax-exempt mission of the Medical Center;
  • any action that would grant any third party the right to appoint directors of the Medical Center;
  • a joint operating agreement or similar arrangement under which the Medical Center’s governance is substantially subject to a board or similar body that the Medical Center does not control; and
  • the sale or transfer of all or substantially all of the Medical Center’s assets.

The IRS determined that, although the above rights certainly represent a form of control over the Medical Center, such control is qualitatively different from the operational control factors that were not present here.

The key to the ruling is that the University’s rights do not confer the power to cause the Medical Center to act. Rather they confer the power to bar the Medical Center from taking certain actions. The right merely limits the Medical Center’s capacity to deviate from the charitable mission it shares with the university and diminishes the chance that the Medical Center will stray from the quality standards and community focus that the University wants in an academic medical center.

Background on Tax Exempt Control Group Rules

In the case of an organization that is exempt from tax under Code section 501(a), the employer includes the exempt organization and any other organization that is under common control with that exempt organization under the special rules set forth in Treas. Reg. §1.414(c)-5(b).

For this purpose, common control exists between an exempt organization and another organization if at least 80 percent of the directors or trustees of one organization are either representatives of, or directly or indirectly controlled by, the other organization. Treas. Reg. §1.414(c)-5(b). A trustee or director is treated as a representative of another organization if he or she also is a trustee, director, agent, or employee of the other organization. A trustee or director is controlled by another organization if the other organization has the general power to remove such trustee or director and designate a new trustee or director. Whether a person has the power to remove or designate a trustee or director is based on all the facts and circumstances. Id.

In the case of PLR 201811009, the University controlled far less than 80% of the Medical Center’s board positions, so the analysis focuses on the “facts and circumstances” element of control. The key takeaway is that the power to prevent another entity from acting does not necessarily result in control. Keep in mind, however, that PLRs are fact specific and can only be relied on by the taxpayer to whom they are issued. We therefore cannot conclude that the power to preclude action by another 501(c)(3) entity will never result in control.

Budget Act Relaxes Hardship Distribution Rules

The Bipartisan Budget Act of 2018, which was signed into law on Friday, February 9, 2018, changes the rules related to hardship distributions from qualified defined contribution plans, effective for Plan Years starting after December 31, 2018, in three significant ways:

  • The Act removes the requirement that Participants exhaust the ability to take any available loans under the plan before taking a hardship distribution.
  • The Act allows Participants to take a hardship distribution from their elective deferral contribution accounts, qualified nonelective contributions (“QNECs”), and qualified matching contributions (“QMACs”), as well as from earnings on those contributions. Previously, hardship distributions could only be taken from elective deferral contributions only, and not from any earnings on deferrals.
  • The Act repeals the rule prohibiting participants from making elective deferrals and other employee contributions for six months after taking a hardship distribution.

Employers that want to implement any or all of the above relaxations in the hardship distribution rules will almost certainly need to amend their plans. While I am generally not a fan of permitting hardship distributions in qualified plans, because they undermine the purpose of retirement savings and add administrative complexity, if your plan provides for hardship distributions you will probably want to incorporate these changes because they will simplify and streamline plan administration.

Tax Cuts and Jobs Act Includes Employee Benefits Changes and Elimination of ACA Individual Mandate Penalty

The Tax Cuts and Jobs Act, which the President signed into law on December 22, 2017 enacts significant tax reforms that include a number of employee benefits changes. Significant employee benefits changes include:

Individual Mandate Repeal. 

Effective in 2019, the Act will reduce to zero the individual shared responsibility (individual mandate) penalty. This will inevitably lead to more people deciding not to purchase health insurance. Coupled with guaranteed issue, which remains the law, this will contribute to the potential “death spiral” in the individual insurance market.

Extended Rollover Period for Qualified Plan Loans. 

If a participant’s account balance in a qualified retirement plan is reduced to repay a plan loan and the amount of that offset is considered an eligible rollover distribution, the offset amount can be rolled over into an eligible retirement plan. Under current law, the  rollover must occur within 60 days. The legislation extends the 60-day deadline until the due date (including extensions) for the participant’s tax return for the year in which the amount is treated as distributed. Plan loan offset amounts qualifying for this extended deadline are limited to loan amounts that are treated as distributed solely by reason of either termination of the plan or failure to meet the loan’s repayment terms because of a severance from employment.

New Employer Tax Credit for Paid Family and Medical Leave. 

The Act creates a new tax credit for eligible employers providing paid family and medical leave to their employees. To be eligible, employers must have a written program that pays at least 50% of wages to qualified employees for at least two weeks of annual paid family and medical leave.

Eligible employers paying 50% of wages may claim a general business credit of 12.5% of wages paid for up to 12 weeks of family and medical leave a year. The credit increases to as much as 25% if the rate of payment exceeds 50%. The provision is generally effective for wages paid in taxable years beginning after December 31, 2017, and before January 1, 2020. Leave provided as vacation, personal leave, or other medical or sick leave is not considered to be family and medical leave eligible for this credit.

Moving Expense Deduction Eliminated. 

For an eight-year period starting in 2018, most employees will not be able to exclude qualified moving expense reimbursements from income or deduct moving expenses. During that period, the exclusion and deduction are preserved only for certain members of the Armed Forces on active duty who move pursuant to a military order.

Qualified Transportation Plans Eliminated. 

The Act eliminates the employer deduction for qualified transportation fringe benefits and, except as necessary for an employee’s safety, for transportation, payments, or reimbursements in connection with travel between an employee’s residence and place of employment.

The tax exclusion for qualified transportation fringe benefits is generally preserved for employees, but the exclusion for qualified bicycle commuting reimbursements is suspended and unavailable for tax years beginning after 2017 and before 2026.

Other Fringe Benefits Deductions Eliminated. 

Effective for amounts paid or incurred after 2017, the Act repeals the rule under Code § 274 that previously allowed a partial deduction for certain entertainment, amusement, and recreation expenses (including expenses for a facility used in connection with such activities) if those expenses are sufficiently related to or associated with the active conduct of the taxpayer’s business.

Also, effective after 2017, the deductibility of employee achievement awards is limited by a new definition of “tangible personal property” that denies the deduction for cash, cash equivalents, and gift cards, coupons, or certificates, except when employees can only choose from a limited array pre-selected or pre-approved by the employer.

Other nondeductible awards include—vacations, meals, lodging, theater or sports tickets, and securities.

Inflation Adjustments. 

Beginning in 2018, many dollar amounts in the Code—including some benefit-related amounts—that are currently adjusted for inflation using the Consumer Price Index for All Urban Consumers (“CPI-U”) will instead be adjusted using the Chained Consumer Price Index for All Urban Consumers (“C-CPI-U”). According to the Bureau of Labor Statistics (which determines and issues the CPI), the C-CPI-U is a closer approximation to a true cost-of-living index for most consumers, and it tends to increase at a lower rate than the CPI-U.