Current developments.

• Author: Elinsky, Peter I.
• Position: Part 1 - Employee benefits

EXECUTIVE SUMMARY

* Rev. Proc. 98-22 combined a number of the IRS's qualified plan correction programs.

* QNECs contributed for HCEs (rare) are counted as elective contributions for the year in which contributed; QNECs for NHCEs are counted in the year for which contributed.

* Rev. Rul. 98-1 provides questions and answers that reflect the changes made to the Sec. 415 rules by the SBJPA, after the technical correction made by the TRA '97.

This two-part article provides an overview of recent developments in employee benefits, including qualified and nonqualified retirement plans, welfare benefits and executive compensation. Part I focuses on recent developments (including those involving the Taxpayer Relief Act of 1997, the Small Business Job Protection Act of 1996 and the Internal Revenue Service Restructuring and Reform Act of 1998) affecting qualified retirement plans, employee stock ownership plans and individual retirement accounts.

This two-part article provides an overview of recent developments in employee benefits, including qualified and nonqualified retirement plans, welfare benefits and executive compensation. Part I, below, focuses on recent developments (including those involving the Taxpayer Relief Act of 1997 (TRA `97), the Small Business Job Protection Act of 1996 (SBJPA) and the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA `98)) affecting qualified retirement plans, employee stock ownership plans (ESOPs) and individual retirement accounts (IRAs). While this article does not provide a comprehensive examination of the specific provisions of the TRA `97, SBJPA and IRSIKRA `98, it does address certain regulatory developments in each. Part II, in the December 1998 issue, will focus on recent developments in welfare benefits, nonqualified retirement plans and executive compensation.

IRS Qualified Plan Guidance

VCR Programs Combined

Rev. Proc. 98-22(1) combined the Administrative Policy Regarding Self-Correction (APRSC) and the Voluntary Compliance Resolution (VCR), the Walk-in Closing Agreement (Walk-in CAP), and the Audit Closing Agreement (Audit CAP) programs. The IRS refers to these coordinated programs as the Employee Plans Compliance Resolution System (EPICS). The EPICS provisions were generally effective Sept. 1, 1998; however, plan sponsors were allowed to use them as of March 9, 1998.

The Tax Sheltered Annuity Voluntary Correction program, affecting Sec. 403(b) plans, was not included in the procedure; the procedure states there will be changes to that program as well.

Overall program changes: Relatively few changes were made to the programs. Rev. Proc. 98-22 made the following changes, which affect all of the programs comprising EPICS:

* Provided a uniform set of correction principles.

* Clarified that there may be more than one appropriate method of correcting qualification failures.

Permitted (in appropriate circumstances) the use of reasonable adjustments in making corrections.

* Permitted taxpayers to rely on the availability of EPICS in correcting qualification failures.

APRSC changes: APRSC enables a qualified plan or Sec. 403(b) plan sponsor to self-correct operational failures it discovers in its plans. The provisions of APRSC were modified and restated to:

* Incorporate the recent extension of the period for correcting significant operational failures from the end of the first plan year following the plan year in which the failure occurred, to the end of the second plan year following the plan year in which it occurred, as set forth in Ann. 97-121.(2)

* Clarify that, for purposes of correcting a failure to satisfy the actual deferral percentage (ADP) or actual contribution percentage (CAP) test, the two-year correction period begins after the expiration of the statutory correction period.

* Permit correction of an operational failure to be completed after the end of the correction period if correction was substantially completed by the end of the correction period. Two important items have not been changed. First, Rev. Proc. 98-22 did not modify the narrow position taken for Sec. 403(b) defects, thus keeping many of such defects out of APRSC. Second, it did not modify the "plan year" rule that permits correction of years not Under examination under the significant defect portion of APRSC.

Changes to VCR: The VCR program enables a qualified plan sponsor to voluntarily disclose to the IRS operational failures it has discovered in its plans and to pay a fixed fee to the IRS. The provisions of VCR were : modified to:

* Reduce the specificity required in the calculations supporting plan sponsors' proposed correction methods.

* Change the circumstances under which closing agreements will be entered into for the Sec. 4974 excise tax (applicable to the failure to satisfy the Sec. 401(a)(9) minimum distribution requirements).

* Extend the period within which corrections are to be made to 150 days.

* Clarify and simplify permissible correction methods under the standardized VCR procedure (SAP) listed in Appendix A of the procedure.

* Provide a checklist for use by plan sponsors in preparing VCR and SAP requests (contained in Appendix B of the procedure).

Changes to Walk-in CAP: The Walk-in CAP enables a qualified plan sponsor to voluntarily disclose to the IRS qualification failures it has discovered in its plans and to pay a compliance correction fee. The provisions of Walk-in CAP were modified to:

* Discontinue the use of 40% (or any other percentage) of the maximum payment amount as the basis for calculating sanctions (except for egregious failures).

* Provide for greater predictability and consistency, by replacing the prior sanction structure with a limited range of compliance correction fees, with the lowest fees provided for small plans using the IRS's chart (provided below).

Walk-in CAP Compliance Correction Fees Number of Fee Presumptive participants range amount 10 or fewer VCR fee(*) to $ 4,000 $ 2,000 11 to 50 VCR fee(*) to $ 8,000 $ 4,000 51 to 100 VCR fee(*) to $12,000 $ 6,000 101 to 300 VCR fee(*) to $16,000 $ 8,000 301 to 1,000 VCR fee(*) to $30,000 $15,000 over 1,000 VCR fee(*) to $70,000 $35,000 (*) Asterisks refer to the applicable VCR fee amount had the plan been submitted under the VCR program.

* Provide a checklist for use by plan sponsors in preparing Walk-in CAP requests (contained in Appendix B).

Changes to Audit CAP: Audit CAP, a program established in the key district offices and available on examination of a qualified plan, enables the plan sponsor to negotiate a monetary sanction. The provisions of Audit CAP were modified and restated to:

* Clarify that the sanction imposed under Audit CAP will not be excessive and will bear a reasonable relationship to the nature, extent and severity of the failure.

* Provide assurance that correction made before audit (even for failures corrected outside of the APRSC, VCR and Walk-in CAP programs) will be an important factor in reducing the potential sanction under Audit CAP.

Miscellaneous: Rev. Proc. 98-22's Appendix B includes a 26-item checklist to review the completeness of any VCR/SVP/Walk-in CAP submission. Not every item applies to every program.

Because plans under examination are not eligible for VCR/SVP/Walkin CAP, terminating plans will want to do a thorough diagnostic check before submitting Form 5310, Determination Letter Regarding Plan Termination. The procedure included in its definition of "under examination" notification from the district office that such an application may have termination problems.

The correction principles clarified that correction of an ADP failure after the one-year statutory period will typically include contributions to, not just distributions to, highly compensated employees (HCEs).

The procedure formalized a $20 de minimis correction level. Thus, if the total to be distributed to an employee as a correction allocation is $15, the distribution does not need to be made.

The procedure precludes negotiation of the minimum required distribution excise tax. If the employer wants to deal with the tax, the entire amount (i.e., 100%) must be paid.

Eliminating Age 70 1/2 In-Service Distributions

The IRS released final regulations(3) permitting qualified plans to eliminate distributions to certain currently employed workers after age 70 1/2. In general, the final regulations, which apply to plan amendments adopted and effective after June 5, 1998, retained the structure and substance of the proposed regulations issued in July 1997, with only a few changes and clarifications. Thus, the conditions for such amendments are:

* The amendment eliminating this payment option applies only to employees who attain age 70 1/2 in or after a calendar year that begins after the later of Dec. 31, 1998 or the amendment's adoption date.

* Amendments must not eliminate any payment option for those retiring after age 70 1/2 that would have been available had the individual retired at age 70 1/2.

* Any amendment to the plan to eliminate the in-service distribution to those age 70 1/2 must be made by the end of the remedial amendment period that applies to the plan for changes under the SBJPA. For plans maintained under one or more collective bargaining agreements ratified before Sept. 3, 1998, the amendment deadline is extended to the last day of the twelfth month beginning after the date on which the last of such collective bargaining agreements terminates (determined without regard to any extensions after Sept. 2, 1998), if later than the last day of the plan's remedial amendment period for SBJPA changes.

A problem arose under Sec. 411(d)(6) when SBJPA Section 1404 repealed the requirement under Sec. 401(a)(9) that mandatory minimum distributions be paid from qualified retirement plans once an individual reached age 70 1/2, even though that individual was still working for the plan sponsor. This repeal, effective beginning in 1997, led plan sponsors to believe they could...