Here are some of the more important developments CPAs need to make their clients and employers aware of for 2006.
Executive compensation rules under IRC section 409A. The American Jobs Creation Act’s new IRC section 409A makes sweeping changes to the tax rules governing nonqualified deferred compensation arrangements such as executive retirement, severance pay and 401(k) “wrap” plans. Section 409A also requires that employers report amounts deferred each year to the IRS. In notice 2005-94, the IRS suspended the reporting and withholding requirements under IRC section 409A for 2005. (Further guidance on this is expected.)
Automatic IRA rollover amendment. Changes to EGTRRA rules require that cash-outs from qualified retirement plans with a present value between $1,000 and $5,000 be automatically rolled over to an IRA unless the participant affirmatively elects otherwise. Employers can eliminate cash-out distributions with a present value of more than $1,000. The IRS revised the deadline for amending plans for the automatic rollover provision until the later of December 31, 2005, the end of the plan year that encompasses March 28, 2005, or the tax filing deadline for the employer’s tax year containing March 28, 2005.
Section 125 plan grace period. Under IRS notice 2005-42, companies can amend IRC section 125 cafeteria plans to provide for a 2 12 month grace period following the end of each plan year for health and dependent care flexible spending accounts (FSAs). Participants who have unused benefits or contributions from the immediately preceding plan year, and who incur expenses for the same qualified benefit during the grace period, may be paid or reimbursed for those expenses as if they had been incurred during the immediately preceding plan year. Employers may adopt a grace period for the current plan year (and subsequent plan years) by amending their plan documents before the end of the current plan year.
Final 401(k) regulations. The IRS issued final regulations for 401(k) plans effective for plan years beginning on or after January 1, 2006. Among other changes the IRS added funeral expenses and the cost to repair damage to an employee’s principal residence to the list of reasons for plan hardship withdrawals. It also provided more guidance on whether amounts paid to terminated employees are eligible for deferral under a 401(k) plan.
Roth contributions. Beginning in 2006, employers can offer employees the option to make after-tax elective contributions under their 401(k) and 403(b) plans in addition to traditional pre-tax elective contributions. These Roth elective contributions are made with after-tax dollars and are, therefore, currently includible in income and subject to employment taxes when contributed—but qualified distributions of Roth elective contributions and related earnings are excludible from income and not subject to employment taxes. Adding the Roth elective contribution feature to an existing 401(k) plan or 403(b) plan will require some administrative and recordkeeping changes as well as amendments to address a host of legal issues. CPAs will need to prompt their companies and clients to revise election forms and communicate the changes to plan participants. Calendar-year plans will have until December 31, 2006, to adopt an amendment for Roth contributions made in 2006.
Definition of dependent. The IRS modified the definition of dependent effective January 1, 2005, and made further technical corrections to the definition under the Gulf Opportunity Zone Act of 2005. The income limit is waived for health and dependent care FSAs and HSAs.
HIPAA security. Large health plans (those with $5 million or more in premiums or claims) that maintain or receive electronic protected health information were required to become compliant with security requirements of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) as of April 20, 2005. Small health plans (with less than $5 million in premiums or claims) have until April 20, 2006, to become compliant by assessing risks; implementing administrative, physical and technical safeguards; training the health plan workforce; preparing and updating various documents such as plan amendments and business associate agreements; and creating internal policies and procedures. Because of the technical aspects of the HIPAA security standards, IT staffs will need to review computer networks, workspaces and electronic media.
HIPAA portability. Final regulations under HIPAA’s portability rules require group health plans to allow individuals to enroll in the plan upon the occurrence of certain events and provide a notice of HIPAA special enrollment rights; to update and issue certificates of creditable coverage when someone’s coverage ends; and to eliminate hidden preexisting condition exclusions and provide certain notices. These final HIPAA rules became effective on the first day of the first plan year beginning on or after July 1, 2005 (January 1, 2006, for calendar-year plans).
Bankruptcy Reform Act impact. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 significantly affects the retirement plans of both individual debtors and employers that filed bankruptcy petitions on or after October 17, 2005. For example, in order for an individual debtor’s pension benefits to qualify for bankruptcy protection, the debtor must demonstrate they are held in a tax-qualified plan. (For more information on the act’s impact, see “ Protect Retirement Assets , ” JofA , Jan.06, page 36.)
Medicare Part D. The Medicare Prescription Drug Improvement and Modernization Act of 2003 added a new benefit effective January 1, 2006. Employers that provide prescription drug coverage to retirees can keep existing coverage and apply for a government subsidy; offer a wraparound plan and make Part D coverage primary; sponsor a Medicare Part D prescription drug plan; contract directly with a prescription drug plan to offer a private label plan; drop prescription drug coverage for retirees; or continue their current funding arrangement without applying for a government subsidy. Employers must send notice of the requirements to active and retired employees (or their spouses/dependents) who are eligible for Part D, and to the Centers for Medicare and Medicaid Services (CMS).
Section 403(b) plans. The IRS is expected to issue final regulations some time in 2006, but they will not become effective earlier than January 1, 2007. One proposed change would require 403(b) plan sponsors to adopt a written plan document. Meanwhile, the IRS has identified seven recurring mistakes in administering 403(b) plans: failure to be a qualified employer, to properly apply universal availability, to limit employee elective deferrals to the maximum annual contribution limits, to return excess elective deferrals and earnings in a timely manner, to properly withhold and report withholdings on form 941, to identify and report defaulted loans and to satisfy hardship distribution requirements.
Staggered remedial amendment cycle for plan restatements. The IRS has implemented a new system of staggered remedial amendment periods for the issuance of determination letters for qualified retirement plans (see table below). Plans will have a five-year staggered cycle and will be assigned to one of five five-year cycles (cycles A through E) based on the last digit of the plan sponsor’s employer identification number (EIN). Starting February 1, 2006, the IRS extended the remedial amendment period for plans operating in good faith with the Economic Growth and Tax Relief Reconciliation Act of 2001 and certain other plan-qualification provisions.
|Next 5-year |
amended cycle ends
|1 or 6||A||2/1/06–1/31/07||1/31/2007||1/31/2012|
|2 or 7||B||2/1/07–1/31/08||1/31/2008||1/31/2013|
|3 or 8||C||2/1/08–1/31/09||1/31/2009||1/31/2014|
|4 or 9||D||2/1/09–1/31/10||1/31/2010||1/31/2015|
|5 or 0||E||2/1/10–1/31/11||1/31/2011||1/31/2016|
New IRS user fee schedule for 2006. The IRS raised selected user fees—including those for determination letter requests, employee plan (EP) letter rulings and exempt organization (EO) letter rulings. EP compliance correction fees under the IRS Employee Plans Compliance Resolution System are not subject to these hikes. See www.irs.go v for a complete list.
IRS, Treasury priority guidance for 2006. The IRS and the Treasury Department’s guidance plan for 2005–2006 includes
- Additional legal requirements for reporting tax shelters under the American Jobs Creation Act.
- Information on the tax treatment of Roth retirement plan distributions.
- Section 529 regulations regarding qualified tuition programs for higher education.
- Information on benefits not permitted in defined benefit plans.
- Final regulations regarding disclosure requirements for the relative value of optional forms of benefit upon a participant benefit election.
- Additional information on debit cards in employer-provided medical expense reimbursement.
Note: This list is not intended to be comprehensive or to provide all of the information needed to comply.
Source: Robin S. Lazarow, JD, chair of Mirick O’Connell’s Employee Benefits and Executive Compensation Practice Group, Westborough, Mass., firstname.lastname@example.org .