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.
Last digit EIN |
Plan’s cycle | Determination letter
filing period | Last day EGTRRA RAP |
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., rslazarow@modl.com .