Current developments in employee benefits and compensation.

• Author: Richardson, Terry

Sitting down to write this article brings to mind the old cliche: The only thing certain in life is change. While there continues to be much debate over it, the Patient Protection and Affordable Care Act of 2010 (1) (the health care law) is the law of the land. Much has changed in 2013 in compensation and employee benefits as regulatory agencies issued guidance on the implementation of the health care law's phased-in provisions (many of which were designed to pay for the health care law through the Code). However, while the health care law garnered much of the attention this past year, other developments unrelated to the new law in the employee plans area were just as significant--including the American Taxpayer Relief Act of 2012 (ATRA) (2) and the Supreme Court's decision in Windsor. (3)

ATRA and Treasury Guidance Affecting Qualified Plans

ATRA eliminated the sunset provisions set to take effect after 2012 and made permanent many of the 2001 and 2003 tax cuts, except for the top marginal income tax rates. For trusts that fund qualified plans and voluntary employees' beneficiary association (VEBA) trusts subject to unrelated business income tax, the top marginal tax rate increased from 35% to 39.6%; (4) the top rate applies to taxable income over $11,950 in 2013. (5) In addition, although ATRA retained the favorable tax treatment for qualified div-idends--i.e., taxing qualified dividends at capital gains tax rates--the maximum capital gains rate was increased to 20% beginning in 2013. (6) Therefore, VEBAs subject to unrelated business income tax on their investment income must now consider the increased ordinary income and capital gains tax rates when calculating 2013 estimated tax payments and making funding decisions regarding the trusts' reserves going forward). (7)

ATRA also included as a revenue raiser an expansion of individual taxpayers' ability to convert existing tax-deferred accounts in Secs. 401(k), 403(b), and governmental 457(b) plans to Roth accounts within the same plan. Provided the plan provides for Roth contributions and in-plan Roth conversions, any participant should generally be able to elect an in-plan Roth conversion, regardless of whether the participant has otherwise had a distributable event such as separation from service or reaching age 59 1/2. Conversions to Roth IRAs are taxable, which is why this provision was enacted as a revenue raises but the special rule exempts these conversions from the 10% penalty under Sec. 72(t). (8) This change is effective for conversions after Dec. 31, 2012. (9)

Other than ATRA, not much occurred on the legislative front. Similarly, on the regulatory front, with few exceptions, the agencies' efforts were more focused on preparing to implement the health care law. However, final regulations under Sec. 411(d)(6) were amended to add a limited exception to the anti-cutback rules permitting a plan sponsor that is a debtor in a bankruptcy proceeding to amend a single-employer defined benefit plan to eliminate a single-sum distribution option (or other optional form of benefit providing for accelerated payments), effective after Nov. 8, 2012. (10)

The IRS also extended the deadline for amending defined benefit plans to satisfy Sec. 436's funding-based limits on benefits and benefit accruals until the later of the last day of the 2013 plan year, the last day of the plan year for which Sec. 436 is first effective for the plan, or the due date (including extensions) for the employer's federal tax return for the tax year that contains the first day of the plan year for which Sec. 436 is first effective for the plan. (11)

Federal Recognition of Same-Sex Marriages

In Windsor, the Supreme Court held that Section 3 of the Defense of Marriage Act (DOMA), (12) which barred federal recognition of same-sex marriages, is unconstitutional. Within months, both the IRS and the Department of Labor announced they would follow a "state of celebration" rule in determining marital status. (13) Therefore, a same-sex couple who are legally married according to the laws of a state or foreign country that recognizes same-sex marriages are now treated as married for federal tax purposes, including the qualification requirements for qualified plans, regardless of where the couple live. The status of a couple who enter into a registered domestic partnership, civil union, or other formal relationship that is not a marriage under state or foreign law is not changed; those couples are not treated as married for federal tax purposes or the qualification requirements for qualified plans.

Qualified Retirement Plans

Rev. Rul. 2013-17 requires qualified plans to apply a state-of-celebration rule for purposes of applying any qualification requirements relating to legally married same-sex spouses beginning Sept. 16, 2013. As a result, a same-sex spouse is entitled to all spousal benefits and protections provided to opposite-sex spouses under a qualified retirement plan. Even employers operating only in states that do not currently recognize same-sex marriages are required to treat a same-sex spouse as a participant's spouse for purposes of applying the federal retirement plan qualification requirements that relate to spouses.

Numerous protections apply to spouses of qualified retirement plan participants. For example, defined benefit plans must provide automatic survivor benefits to spouses in the form of a qualified preretirement survivor annuity if a participant dies before normal retirement age, or a qualified joint and survivor annuity (QJSA) upon retirement. Defined contribution plans (e.g., Sec. 401(k), profit sharing, and stock bonus plans) usually satisfy spousal survivor protections by paying the participant's vested account balance upon death to the surviving spouse (unless the spouse consents to a different beneficiary). (14)

The surviving spouse of a deceased participant also has broader rollover rights than does a nonspouse beneficiary, including the right to roll over an eligible distribution to another qualified plan, Sec. 403(b) plan, or governmental Sec. 457(b) plan that allows rollover contributions. A surviving spouse who is the beneficiary of a decedent spouse's IRA may treat it as his or her own and may make rollovers to and from the IRA. While a nonspouse beneficiary may currently roll over a distribution from a qualified plan to an IRA, unlike a spousal beneficiary, he or she may not make any subsequent rollovers from that IRA. (15)

Often coupled with marriage is divorce. As a result of the Windsor decision and Rev. Rut 2013-17, qualified plans are required to recognize qualified domestic relations orders (QDROW involving the division of legally married same-sex couples' assets. Therefore, qualified plan sponsors should ensure QDRO administrative procedures provide for the recognition of QDROs issued upon the dissolution of a legally recognized same-sex marriage.

Same-sex marriage recognition also affects the administration of defined contribution plans that allow participant loans and hardship withdrawals. Many defined contribution plans that offer loans to participants also require spousal consent for the loans. For hardship withdrawal provisions, safe-harbor standards for determining whether a participant has experienced an immediate and heavy financial need include medical, tuition, and funeral expenses incurred by a participant's spouse. Similarly, to determine whether a hardship withdrawal is necessary to satisfy an immediate and heavy financial need, the participant's resources are deemed to include a spouse's assets.

Other favorable provisions that apply to spouses (and will now apply to legally married same-sex spouses) include the application of Sec. 415 limits, which generally ignore the value of a spouse's survivor benefit under a QJSA when adjusting a benefit under a defined...