Employee Benefits & Executive Compensation Benefits Alert – Summer 2006
Nonqualified Deferred Compensation
June 30 Deadline for Bonus Deferral Elections
Calendar-year sponsors of nonqualified deferred compensation plans should be aware that the June 30 deadline is looming for participants to elect to defer performance-based bonuses earned in 2006.
Normally, deferral elections must be made prior to the beginning of the taxable year in which the compensation is earned. However, new section 409A of the Internal Revenue Code allows plans to extend the election deadline for certain forms of performance-based compensation until mid-year. Proposed regulations define “performance-based compensation” as compensation where the amount of, or entitlement to, the compensation depends on the satisfaction of pre-established organizational or individual performance criteria that are established in writing no later than 90 days after the beginning of a service period. If you are unsure whether the bonus deferral feature of your nonqualified plan qualifies for this extended deadline, contact any member of K&C’s Employee Benefits Group.
Also note that amendments to bring plans into compliance with section 409A must generally be adopted by December 31, 2006. Now is the time to inventory necessary changes and begin drafting amendments to all nonqualified plans that are subject to section 409A.
Beware of 401 (k) Pre-funding
A wrinkle in the recently finalized set of 401(k) regulations has caught some plan sponsors off guard: a prohibition against “pre-funding” of elective deferral contributions. Under the new regulations, a contribution to a 401(k) plan will not be treated as a contribution of elective deferrals if it is made before the earlier of (i) the last day of the pay period from which the deferral was deducted from employees’ pay; or (ii) the date on which the employees actually receive their paychecks for that period.
This rule is particularly problematic to 401(k) sponsors who submit their plan contributions electronically via automatic deposit. Plan sponsors should contact their payroll processors and third-party administrators as necessary to ensure that elective deferral contributions are not received by the trust until after the end of the pay period to which they relate. Limited exceptions apply under the regulations for occasional early deposits for bona fide administrative reasons, but the easiest way to ensure compliance with this new rule is to design your contribution procedures so those plan contributions are not made until a day or two after the end of the pay period to which they relate.
Revised EPCRS Procedures Take Some of the Pain Out of the Plan Corrections
The IRS has recently published changes to the Employee Plans Compliance Resolution System (EPCRS), the program under which plan sponsors are permitted to voluntarily correct certain plan qualification failures. Revenue Procedure 2006-27, published in April 2006, updates and streamlines the EPCRS program by listing additional correctable transactions, reducing documentation requirements, and providing a simplified application form and online calculator. The changes collectively make the process of correcting plan qualification failures more “user-friendly” than it has ever been before.
Now maybe the time to conduct a compliance audit and correct any qualification failures that may have escaped your attention previously. Members of our team are standing by to assist you at any stage of this process.
EGTRRA Staggered Determination Letter Cycle
Sponsors of individually designed qualified plans should begin to plan ahead for the upcoming EGTRRA remedial amendment period. Under new IRS rules effective this year, plan sponsors are assigned one of five staggered remedial amendment cycles based on the last digit of the sponsor’s employer identification number (EIN), as follows:
|Last Digit of EIN||Remedial Amendment Period Ends|
|1 or 6||January 31, 2007|
|2 or 7||January 31, 2008|
|3 or 8||January 31, 2009|
|4 or 9||January 31, 2010|
|5 or 0||January 31, 2011|
Plan sponsors with EINs ending in 1 or 6 have until January 31, 2007 to (i) adopt finalized amendments incorporating all post-GUST required legislative changes, including EGTRRA; and (ii) submit an application for an IRS determination letter covering these changes. Note that this deadline only applies to individually designed plans; plans that are adopted on a prototype or volume submitter document do not need to be amended or filed with the IRS at this time.
Recent Case Bolsters Fiduciary Protection Offered by Independent Fiduciaries
ESOP fiduciaries can sleep a little easier following a recent decision in which the Seventh Circuit Court of Appeals held that an independent trustee’s actions in reviewing and approving a valuation of employer securities for purposes of an ESOP transaction must be reviewed by the court under a deferential “abuse of discretion” standard. Armstrong v. LaSalle Bank N.A.
The Department of Labor (DOL) had filed an amicus curiae brief in the case arguing that courts should give no deference whatsoever to the fiduciary decisions of an ESOP trustee, whether or not the trustee operated under a conflict of interest. The court rejected the DOL’s approach and held instead that where a trustee has no conflict of interest and is not engaged in self-dealing, the trustee’s decisions can be set aside only if a court finds that the trustee abused its discretion — a fairly difficult evidentiary for plaintiffs to meet.
This case illustrates the important protective role played by independent fiduciaries in an ESOP transaction. Employers and shareholders who have previously been reluctant to sell their shares to an ESOP due to fear of potential fiduciary liability may want to re-visit the issue in light of this decision, which makes clear that the risk of fiduciary liability can be significantly reduced by retaining an independent fiduciary to approve the valuation and other material terms of an ESOP transaction.
Proposed Dependent Care Expense Regulations Published
In May 2006, the IRS issued updated proposed regulations concerning dependent care expenses. The regulations make several changes that may have an impact on employers who sponsor dependent care spending account arrangements. Among the highlights of the regulations are the following changes and clarifications:
- Clarification that expenses are only eligible in the later of, the year in which the services are provided, or the year the expenses are paid;
- Disallowance of kindergarten expenses, which are deemed primarily for education;
- Allowance of limited transportation expenses incurred by a dependent care provider; and
- Clarification that payments made to the taxpayer’s spouse or the child’s parent are not eligible expenses.
These proposed regulations are not effective until finalized but may be applied to current dependent care spending account issues. Sponsors of dependent care spending accounts should review applicable summary plan descriptions and employee communication materials to ensure compliance with these new regulations.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.