Qualified Plan Provisions of the Tax Reform Act of 1986-part Ii
| Publication year | 1987 |
| Pages | 595 |
1987, April, Pg. 595. Qualified Plan Provisions of the Tax Reform Act of 1986-Part II
R. Michael Sanchez and Cynthia C. Benson, Denver, are partners in the firm of Sherman & Howard. Michelle G. Reiff is an associate of that firm.
This article is the second of two parts discussing the qualified plan provisions of the Tax Reform Act of 1986 ("TRA").(fn1) The first part, published in the March 1987 issue at page 427, covered those provisions that have become effective already or will become effective during 1987. This second part discusses those provisions that become effective in 1989, along with provisions affecting employee stock ownership plans ("ESOPs"). This part also discusses the amendments to the AGe Discrimination Act.
The new participation, vesting and integration rules that form the core of the TRA are effective for plan years beginning after 1988.(fn2) The TRA also specifices that plans are not required to be amended to conform either to the new rules that are effective in 1986 or 1987 or to the new rules that become effective with the 1989 plan year until the 1989 plan year.(fn3) However, when made, such an amendment must be reroactive, and the plan must be administered in accordance with the applicable new rules until the amendment is made.(fn4)
To become qualified or to remain qualified, a retirement plan must satisfy new coverage and participation tests set forth in Interal Revenue Code of 1986 ("Code") §§ 410 and 401 (a)(26).
As under current law, certain employees may be excluded in applying the coverage tests: (1) union employees who are covered by a collective bargining agreement if retirement benfits were subject to good faith bargaining (unless the plan covers union employees); (2) certain airline pilts; and (3) nonresident aliens earning no United State-source income.(fn5) Empolyees who do not meet the plan's minimum age and service requirements also may be excluded, but for purposes of the average benefits tests (see definition below), only those employees failing to meet the lowest age and service requiremnts of any plan maintained by the employer may be excluded.(fn6)
Employees covered under a collective bargining agreement are disregarded when applying the percentage, ratio or average benefits tests (see definition below) to employees not covered by a collective bargining agreement. However, in applying those tests to employees who are covered by a collective bargaining agreement, the emplyer may not disregard employees not covered by such an agreement.(fn7)
As amended by the TRA, Code § 410(b) requires a plan to satify one of three coverage tests: a percentage test, a ratio test, or an average benefits test.
To satisfy the percentage test, the plan must benfit at least 70 percent of all non-excluded employees who are not highly compensated employees.(fn8) For example, an emplyer with four non-highly compensated employees who are not excludible must cover at least three to satisfy the test. The ratio test is satisfied if the percentage of non-excluded non-highly compensated employees benefited by the plan is at least 70 percent of the percentage of non-excluded highly compensated employees benefiting under the plan.(fn9) For example, if the plan benefits 60 percent of the includible highly compenstaed employees, then the plan must benefit at least 42 percent of the includible non-highly compensated employees. The Conference Report to the TRA notes that a plan automtically is deemed to satisfy the coverage tests if the employer has no non-highly compensated employees.(fn10)
The average benefits test is actually a two-part test. First, the plan must cover employees in a classification found not to discrminate in favor of highly compensted employees.(fn11) The second test is a
To calculate the average benefit percentage, the employer must take the average of each employee's "benefit percentage." A benefit percentage is defined as the total employer-provided contributions or benefits for the employee, including forfeitures and elective deferrals, under all employer-maintained plans as a percentage of compensation.(fn13) If benefit percentages are determined on the basis of contributions, all employer-provided benefits must be converted to contributions, and if tested on the basis of benefits, all contributions must be converted to benefits.(fn14) The percentage may be computed on the basis of benefits or contributions for the plan year or for a period of up to three consecutive years ending with the plan year, if so elected by the employer.(fn15)
The election may be revoked or modified only with the consent of the Secretary of Treasury.(fn16) The rules are to be applied separately to former employees.(fn17) Furthermore, if an employer is treated as operating separate lines of business, then the coverage tests may be applied separately with respect to employees in each separate line of business.(fn18)
If a plan fails to meet the coverage tests, highly compensated employees are taxed on the value of their vested benefits attributable to employer contributions and income thereon (if not previously taxed), while non-highly compensated employees are not taxed. This change will make enforcement a much easier proposition for Internal Revenue Service ("IRS") agents because it gives them a sanction other than disqualification. This new sanction is in addition to the currently applicable disqualification sanctions.(fn19)
Effective for plan years beginning after December 31, 1988, each separate plan of an employer must satisfy new minimum participation rules enacted under the TRA.(fn20) These rules require that on each day of the plan year, the plan must benefit the lesser of fifty employees or 40 percent of all employees of the employer.(fn21) The purpose and effect of the minimum participation rules is to stop practices that provide substantially increased benefits for owners, such as defined benefit plans for owners with comparable offsetting defined contribution plans or separate plans for employees. Practitioners should analyze carefully each situation in which a client has more than one plan to determine how these rules may apply.
Employees eligible to elect cash or deferred contributions are considered to benefit under the plan if they do not contribute.(fn22) In determining whether 40 percent of the employees are benefited under the plan, certain employees may be excluded. The permitted exclusions are generally the same exclusions permitted under the coverage test of Code § 401 as described above.(fn23)
The IRS is given authority to treat separate benefit structures or other separate arrangements as separate plans for purposes of the minimum participation tests.(fn24) In other words, an employer cannot combine plans with different benefits into one document or trust to meet the participation test. The TRA Conference Report provides examples of arrangements that may be separate plans for purposes of the participation tests.(fn25) Some examples include payment of benefits from more than one source, different formulas for determining benefits or contributions, priority rights to plan assets or reversions, and participant investment direction of defined benefit plan assets. The rules regarding separate plans establish a facts and circumstances test under which the IRS will have broad authority to prevent avoidance of the participation tests.
The TRA does provide some relief for certain plans in existence on August 16, 1986. Plans that would not have satisfied the new participation tests for the plan year...
To continue reading
Request your trial