Sample Plan Language for IRC Section 409(p) Transfers

Employee Plans News - Special Edition, July 1, 2008 announces that Sample Plan Language for Section 409(p) Transfers is now available:

Non-ESOP Portion of Plan

1. Non-ESOP Portion. Assets held under the Plan in accordance with this Section are held under a portion of the Plan that is not an employee stock ownership plan (ESOP), within the meaning of section 4975(e)(7) of the Internal Revenue Code. Amounts held in the portion of the Plan that is not an ESOP (the Non-ESOP portion) shall be held in accounts that are separate from the accounts for the amounts held in the remainder of the Plan (the ESOP portion). The statements provided to Participants and Beneficiaries to show their interest in the Plan shall separately identify the amounts held in each such portion. Except as specifically set forth in this Section, all of the terms of the Plan apply to any amount held under the Non-ESOP portion of the Plan in the same manner and to the same extent as to any other amount held under the Plan.

2. Transfers from ESOP to Non-ESOP Portion of Plan. (a) In the case of any event that the Plan Administrator determines would cause a nonallocation year (as defined in section xxx of the Plan) to occur (referred herein as a "nonallocation event"), shares of employer stock held under the Plan before the date of the nonallocation event, shall be transferred from the ESOP portion of the Plan to the Non-ESOP portion of the Plan as provided in (2)(a). Actions that may cause a nonallocation event, include, but are not limited to, a contribution to the Plan in the form of shares of employer stock, a distribution from the Plan in the form of shares of employer stock, a change of investment within a Plan account of a disqualified person (as defined in section xxx of the Plan) that alters the number of shares of employer stock held in the account of the disqualified person, or the issuance by the employer of synthetic equity as defined by section 409(p)(6)(C) of the Internal Revenue Code and section 1.409(p)-1(f) of the Treasury Regulations. A nonallocation event occurs only if (i) the total number of shares of employer stock that, held in the ESOP account of those Participants who are or who would be disqualified persons after taking into account the Participant's synthetic equity and the nonallocation event, exceeds (ii) 49.9% of the total number of shares of employer stock outstanding after taking the nonallocation event into account (causing a nonallocation year to occur as described in Section xxx of the Plan). No transfer under this section shall be greater than the excess, if any, of (i) over (ii). Before the nonallocation event occurs, the Plan Administrator shall determine the extent to which a transfer is required to be made and shall take steps to ensure that all action necessary to implement the transfer are taken before the nonallocation event occurs.

(b)(1) Except as provided for in (b)(2), at the date of the transfer, the total number of shares transferred, as provided for in (a)(1), shall be charged against the accounts of Participants who are disqualified persons (i) by first reducing the ESOP account of the Participant who is a disqualified person whose account has the largest number of shares (with the addition of synthetic equity shares) and (ii) thereafter by reducing the ESOP accounts of each succeeding Participant who is a disqualified person who has the largest number of shares in his or her their account (with the addition of synthetic equity shares. Immediately following the transfer, the number of transferred shares charged against any Participant's account in the ESOP portion of the Plan shall be credited to an account established for that Participant in the Non-ESOP portion of the Plan.

(2) Notwithstanding (b)(1), the number of shares transferred shall be charged against the accounts of Participants who are disqualified persons (1) by first reducing the account of the Participant with the fewest shares (including synthetic equity) who is a disqualified person and who is a Highly Compensated Employee (as defined in Section xxx of the Plan) to cause the Participant not to be a disqualified person, and thereafter reducing the account of each other Participant who is a disqualified person and a Highly Compensated Employee, in order of who has the fewest ESOP shares (including synthetic equity). A transfer under this (b)(2) only applies to the extent that the transfer results in fewer shares being transferred than in a transfer under (b)(1).

(c) (1) If two or more Participants described in (b) have the same number of shares, the account of the Participant with the longest service shall be reduced first.

(2) Beneficiaries of the Plan are treated as Plan Participants for purposes of this section.

3. Income Taxes. If the Trust owes income taxes as a result of unrelated business taxable income under section 512(e) of the Internal Revenue Code with respect to shares of employer stock held in the Non-ESOP portion of the Plan, the income tax payments made by the Trustee shall be charged against the accounts of each Participant or Beneficiary who has an account in the Non-ESOP portion of the Plan in proportion to the ratio of the shares of employer stock in such Participant's or Beneficiary's account in the non-ESOP portion of the Plan to the total shares of employer stock in the non-ESOP portion of the Plan. The Employer shall purchase shares of employer stock from the Trustee with cash (based on the fair market value of the shares so purchased) from each such account to the extent necessary for the Trustee to make the income tax payments.

California’s Franchise Tax Board (FTB) Notice 2008-4 – Resolution of Certain ESOP Transactions

California's Franchise Tax Board (FTB) recently announced that taxpayers who filed a tax return that included "certain ESOP transactions" should resolve their accounts to avoid penalties:

The Franchise Tax Board (FTB) announced that taxpayers who filed a state income tax return or an amended return that included a state tax benefit from transactions referred to as either "bogus optional basis" (BOB) transactions or certain "employee stock ownership plan" (ESOP) transactions may qualify for relief from the noneconomic substance transaction (NEST) penalty.

Eligible California taxpayers have from June 23 to September 12, 2008, to resolve certain transactions that may be subject to the NEST penalty. To participate, taxpayers must submit a signed and completed closing agreement (FTB Notice 2008 - 4) on or before September 12, and pay all tax, penalties, and interest relating to the conceded tax benefits in full.

If a taxpayer previously received a Notice of Proposed Assessment (NPA) that included a 40 percent NEST penalty, FTB's Chief Counsel will use his authority under the tax code to reduce the NEST penalty from 40 percent to 20 percent. To receive the penalty reduction, the taxpayer must pay the revised penalty amount in full when submitting the closing agreement.

For taxpayers who paid a 40 percent NEST penalty prior to the date of this notice, FTB's Chief Counsel will reduce the penalty to 20 percent and refund any overpayment that is within the applicable statute of limitations. The taxpayer must fully comply with the terms of FTB Notice 2008–4.

If the taxpayer previously received an NPA that included a 100 percent interest-based penalty, FTB will abate the penalty if the assessment is still pending.

Taxpayers who have not been mailed an NPA for a BOB or ESOP transaction, whether they are under audit or not, should comply with the requirements of FTB Notice 2008–4. For taxpayers who comply, FTB will assess a 20 percent accuracy related penalty and will not assess the 100 percent interest-based penalty and will be relieved of other potential penalties relating to their participation in the eligible transactions including penalties under Revenue and Taxation Code Sections 19164(c), 19164.5, 19772, 19777, 19778, and former 19773.

FTB estimates that abusive tax shelters cost California $500 million in lost tax dollars each year. FTB will continue to aggressively pursue taxpayers and the promoters who participate in or recommend these tax shelters.

FTB Notice 2008 - 4 – Resolution of Bogus Optional Basis (BOB) Transactions and Certain Employee Stock Ownership Plan (ESOP) Transactions describes the eligible and ineligible transactions:

ESOP Transactions. Transactions involving the use of employee stock ownership plans (ESOPs) that could be subject to a NEST penalty and were not eligible to participate in California's Tax Shelter Resolution Initiative, FTB Notice 2006-1. Three transactions involving ESOPs that were eligible under FTB Notice 2006-1 and that are not eligible under this Notice are: (1) transactions covered by Revenue Ruling 2003-6, 2003-1 C.B. 286; (2) transactions covered by Revenue Ruling 2004-4, 2004-1 C.B. 414; and (3) Management S corporation ESOP transactions described in the IRS's Transaction-specific Frequently Asked Questions released as part of IRS Announcement 2005-80, 2005-2 C.B. 967. The eligible transactions described in this paragraph may be referred to as "certain ESOP transactions."

Transactions, or any part, step or intermediate transactions, that are the same as, or substantially similar to, the following: (1) an ESOP purchases or otherwise obtains, or purports to have obtained, shares of stock or other equity interests in an entity (ESOP Entity) that is or was owned by Taxpayer and/or one or more of its related parties, directly or indirectly, at any time (ESOP Equity Purchase); (2) in one or more of the Taxable Years at Issue, fifty percent or more of the taxable income of the ESOP Entity is or was allocated, directly or indirectly, to the ESOP (ESOP Income Allocation); and/or (3) in one or more of the Taxable Years at Issue, Taxpayer recognized less taxable income from or attributable to (a) the ESOP Entity, and/or (b) the stock or other property transferred to the ESOP Entity than Taxpayer would have otherwise recognized without the ESOP Income Allocation.

One example of an eligible ESOP transaction is the following. Taxpayer A holds 100 percent of the outstanding stock of XYZ Corporation (an S corporation) on December 30, 2000. On December 31, 2000, Taxpayer A forms an ESOP. On January 1, 2001, Taxpayer A sells stock in XYZ Corporation to the ESOP. During tax years 2001 through 2004, Taxpayer A assigns income to XYZ Corporation or otherwise provides services through XYZ Corporation. All income earned or assigned to XYZ Corporation during tax years 2001 through 2004 is allocated to the ESOP. Prior to or on December 31, 2004, XYZ Corporation obligates itself to compensate Taxpayer A for prior services. Such obligation substantially reduces the fair market value of XYZ Corporation. Taxpayer A purchases one or more shares of XYZ Corporation stock from XYZ Corporation. XYZ Corporation repurchases the ESOP's shares of XYZ Corporation stock for substantially less than the fair market value of XYZ Corporation's assets due to its obligation to Taxpayer A. Taxpayer A again holds 100 percent of the outstanding stock of XYZ Corporation. Other variations of this transaction use different methods or obligations to reduce the value and/or increase the adjusted tax basis of XYZ Corporation or its outstanding stock.

Related Links

• FTB Notice 2008 - 4 – Resolution of Bogus Optional Basis (BOB) Transactions and Certain Employee Stock Ownership Plan (ESOP) Transactions
  
• FTB Notice 2006-1 – California Tax Shelter Resolution Initiative – California's Program for Participants in Internal Revenue Service (IRS) Settlement Initiative. Revenue Ruling 2003-6, 2003-1 C.B. 286
  
• IRS Announcement 2005-80, 2005-2 I.R.B. 967 – Settlement Initiative – Management S Corporation ESOP Transactions (Transactions where the taxpayer has claimed that it is entitled to exclude income of an operating business by asserting, incorrectly, that the taxpayer had established, on or before March 14, 2001, an employee stock ownership plan entitled to an exemption from unrelated business income and an S corporation that is a management corporation, and whatever actions that were taken to attempt to establish an employee stock ownership plan and a management S corporation were taken on or before March 14, 2001
  
• IRS Revenue Ruling 2004-4, 2004-6 I.R.B. 414 – Prohibited Allocations of Securities in an S Corporation – Transactions that involve segregating the business profits of an employee stock ownership plan (ESOP)-owned S corporation in a qualified subchapter S subsidiary, so that rank-and-file employees do not benefit from participation in the ESOP
  
• IRS Revenue Ruling 2003-6, 2003-3 I.R.B. 286 – Prohibited Allocations of Securities in an S Corporation – Certain arrangements involving the transfer of ESOPs that hold stock in an S corporation for the purpose of claiming eligibility for the delayed effective date of § 409(p)
  
• FTB Notice 2008-4 Closing Agreement (fill-in PDF)
  
• Instructions for Completing FTB Notice 2008-4 Closing Agreement
  
• Frequently Asked Questions: FTB Notice 2008-4
  

• IRC Section 409(p) Anti-Abuse Testing, History of Regulations, and Private Letter Ruling (PLR) 200804023
  
• Missouri Building LLC v. Clark (In re Seferyn), B.A.P. 10th Cir., No. KS-07-094 (May 15, 2008)
  

Recent California Supreme Court Ruling, Definition of Spouse and Marriage, Defense of Marriage Act (DOMA), and the Impact on Plan Administration

California Supreme Court's Decision on Domestic Partnerships May Raise Some Plan Document Issues discusses how last month's California Supreme Court Ruling (In re Marriage Cases, No. S147999 (May 15, 2008)) could create some plan document issues.

When considering these issues, it is important to consider the impact of the Defense of Marriage Act (DOMA) definition of marriage:

SEC. 3. DEFINITION OF MARRIAGE.

(a) In General.--Chapter 1 of title 1, United States Code, is amended by adding at the end the following:

``Sec. 7. Definition of `marriage' and `spouse'

``In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word `marriage' means only a legal union between one man and one woman as husband and wife, and the word `spouse' refers only to a person of the opposite sex who is a husband or a wife.''

The Impact of Same-Sex Marriage on Employee Benefit Plan puts the DOMA definition in context:

Congress adopted DOMA in 1996 in response to a ruling by the Hawaii Supreme Court that cast serious doubt on the constitutionality of a state law that limited marriage to couples of the opposite sex. One of DOMA's two principal provisions, and the one relevant here, reads as follows:

In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word 'marriage' means only a legal union between one man and one woman as husband and wife, and the word 'spouse' refers only to a person of the opposite sex who is a husband or a wife (1 U.S.C. § 7).

All provisions of the Employee Retirement Income Security Act of 1974 ("ERISA") and the Internal Revenue Code ("Code"), and any regulations promulgated under those laws, which reference a person's marital status must be read in a manner consistent with DOMA's definition of marriage. Our initial assessment is that in the two states actually recognizing same-sex marriages, DOMA's biggest impact is on qualified plans under section 401(a) of the Code — pension plans in particular — with only minimal impact on health and welfare and deferred compensation plans.

The article proceeds to address the qualified plan provisions that DOMA governs:

• Qualified Joint and Survivor Annuities and Spousal Consent
• Optional Joint and Survivor Annuities
• Qualified Pre-Retirement Survivor Annuities
• Qualified Domestic Relations Orders
• Incidental Death Benefit and Minimum Required Distribution Rules
• Rollover Rules
• Preference Beneficiary Rules

Definition of Spouse also discusses the impact of the DOMA definition on plan administration.

As we said, the DOMA definition of spouse is applicable to all Federal laws, agencies, and regulations. And although our written plan document is unaffected by DOMA, in practice, the parties to a same-sex marriage are not recognized as spouses for retirement plan purposes. Thus, there are no spousal rights. What does this mean administratively?

Since the DOMA definition of spouse is not met, the Federal laws involving the word spouse do not apply. Therefore:

• No spousal consent is needed to name someone other than the spouse as beneficiary
• No qualified joint and survivor annuity (QJSA) requirements or protections are provided.
• No qualified pre-retirement survivor annuity (QPSA) requirements or protections apply.
• No spousal consent is needed for distributions, loans or hardship withdrawals.
• The joint life tables for required minimum distributions cannot be used if the same-sex spouse is more than 10 years younger.
• No spousal rollover of the deceased participant spouse's plan assets is permitted.
• In certain defined benefit plan designs, if the participant dies before the earliest retirement age under the plan, no benefits will be paid from the plan on that participant's behalf because the qualified pre-retirement annuity would not be enabled.

The article also addresses the following:

• What is a spouse?
• Who is a spouse?
• Who is a spouse under federal law?
• What is a marriage?
• When is one considered married according to IRC Section 417(d)?
• Impact of DOMA on retirement plan administration
• QDRO Quandary
• So, what is a marriage?

Reporting a Rollover to Roth IRA on IRS Form 1099-R

Earlier this week we discussed the 2009 Change in Reporting Distributions of 404(k) Dividends on IRS Form 1099-R. Reporting Rollovers from Pretax Plan Accounts to Roth IRAs discusses another IRS Form 1099-R reporting issue. It illustrates the reporting of a participant receiving a qualified plan (pre-tax) rollover distribution to a Roth IRA (after-tax) as provided by IRS Notice 2008-30 - Miscellaneous Pension Protection Act Changes by using an example. In the example, the participant is 50 years old, is requesting a distribution of his $100,000 account balance, and is electing that $25,000 be withheld for voluntary withholding. The article discusses how this scenario requires two IRS Forms 1099-R:

The first Form should report $75,000 as a gross (Box 1. Gross Distribution) and taxable (Box 2a. Taxable Amount) distribution and code G—Direct rollover and rollover contribution (Box 7. Distribution Code(s)) to indicate the rollover. Please note that it is unusual for an IRS Form 1099-R with a code G distribution to also report taxable income. Also note that this portion of the distribution is a rollover and is not subject to the IRC Section 72(t) - 10-percent additional tax on early distributions from qualified retirement plans.

The second Form should report $25,000 as a gross (Box 1. Gross Distribution) and taxable (Box 2a. Taxable Amount) distribution and as withholding in Box 4. Federal Income Tax Withheld. Since this portion is not a rollover, code 1—Early distribution, no known exception (Box 7. Distribution Code(s)) should be used to indicate the taxpayer is under age 59 ½ and is subject to IRC Section 72(t) - 10-percent additional tax on early distributions from qualified retirement plans.

Is Your 402(f) Safe Harbor Special Tax Notice Out of Date?

We recently discussed how the 402(f) Safe Harbor Special Tax Notice is out of date. Caution: IRS Model Special Tax Notice is Out of Date summarizes several law changes that must be incorporated into the Safe Harbor Explanation:

1. The automatic rollover requirements under IRC Section 401(a)(31) - Direct transfer of eligible rollover distributions
   
2. Information regarding Rollovers to Roth IRAs, as provided by IRS Notice 2008-30 - Miscellaneous Pension Protection Act Changes
   
3. Changing the days a 402(f) Safe Harbor Special Tax Notice may remain in effect from 90 to 180, as provided by Pension Protection Act of 2006 (PPA) (Public Law 109–280—Aug. 17, 2006)
   
4. "Rollover rules for Roth 401(k) and 403(b) deferrals"

Here is the Explanation to Recipients Before Eligible Rollover Distributions (Section 402(f) Notice) section of the Instructions for Forms 1099-R and 5498 (2008):

The requirements of section 402(f) do not apply to direct rollovers by nonspouse designated beneficiaries.

For qualified plans, section 403(b) plans, and governmental section 457(b) plans, the plan administrator must provide to each recipient of an eligible rollover distribution an explanation using either a written paper document or an electronic medium (section 402(f) notice). The explanation must be provided no more than 90 days (as much as 180 days for plan years that begin after December 31, 2006) and no fewer than 30 days before making an eligible rollover distribution or before the annuity starting date. However, if the recipient who has received the section 402(f) notice affirmatively elects a distribution, you will not fail to satisfy the timing requirements merely because you make the distribution fewer than 30 days after you provided the notice as long as you meet the requirements of Regulations section 1.402(f)-1, Q/A-2. The electronic section 402(f) notice must meet the consumer consent requirements as provided in Regulations section 1.401(a)-21(b).

The notice must explain the rollover rules, the special tax treatment for lump-sum distributions, the direct rollover option (and any default procedures), the mandatory 20% withholding rules, and an explanation of how distributions from the plan to which the rollover is made may have different restrictions and tax consequences than the plan from which the rollover is made. The notice and summary are permitted to be sent either as a written paper document or through an electronic medium reasonably accessible to the recipient; see Regulations section 1.402(f)-1, Q/A-5.

For periodic payments that are eligible rollover distributions, you must provide the notice before the first payment and at least once a year as long as the payments continue. For section 403(b) plans, the payer must provide an explanation of the direct rollover option within the time period described above or some other reasonable period of time.

Notice 2002-3, which is on page 289 of Internal Revenue Bulletin 2002-2 at http://www.irs.gov/pub/irs-irbs/irb02-02.pdf contains model notices that the plan administrator can use to satisfy the notice requirements.

Notice 2002-3 has not yet been updated for requirements related to plans that accept designated Roth account contributions. For distributions from designated Roth accounts, the section 402(f) notice must contain the rollover and taxation rules for the distribution of designated Roth contributions.

The notice also has not yet been updated for the requirements of the Pension Protection Act of 2006.

Involuntary distributions. For involuntary distributions paid to an IRA in a direct rollover (automatic rollover) you may satisfy the notification requirements of section 401(a)(31)(B)(i) either separately or as a part of the section 402(f) notice. The notification must be in writing and may be sent using electronic media in accordance with Q/A-5 of Regulations section 1.402(f)-1. Also see Notice 2005-5, Q/A-15.

The article provides a link to an updated Relius Special Tax Notice.

2009 Change in Reporting Distributions of 404(k) Dividends on IRS Form 1099-R

IRS Announcement 2008-56 – Change in Reporting Section 404(k) Dividends states that beginning with 2009 distributions, 404(k) dividend distributions must be reported on an IRS Form 1099-R that does not report any other distributions.

New Reporting

Distributions from a plan that are made in 2009 or later years and that are § 404(k) dividends must be reported on a Form 1099-R that does not report any other distributions, in accordance with the instructions to the form. Accordingly, if there are other distributions from the plan in such years that are not § 404(k) dividends, they must be reported on a separate Form 1099-R. It is anticipated that the instructions will require a special code in box 7 of the form to indicate the special tax treatment and rollover restrictions applicable to § 404(k) dividends. Payments of § 404(k) dividends made directly from the corporation to the plan participants or their beneficiaries are reported on Form 1099-DIV in accordance with the instructions to that form.

Effect on Other Documents

Announcement 85-168 is revoked.

S Corporation ESOPs and Synthetic Equity Solutions

The ESOP-Owned S Corporation: Bringing Ownership to Life with Synthetic Equity discusses how S Corporations can suffer from a cash drain as distributions are paid to shareholders to cover personal income taxes, ultimately putting the company in the same situation as a C Corporation. This can be avoided by creating a 100% ESOP-owned S corporation:

But what if the sole shareholder is a tax-exempt qualified retirement plan – that is, an ESOP? In that event, neither the company nor its shareholder pays taxes on the company's net earnings, so no cash needs to leave the company in favor of the IRS. In effect, the ESOP-owned S corporation becomes a tax-exempt, for-profit business!

The article describes two limitations of using an ESOP as an employee ownership model: the limited flexibility in determining which employees should get how much ownership and how a dollar given to employees in ownership can have a lesser perceived value, decreasing the attractiveness of an ESOP to younger employees and recruits.

A solution to these problems is to supplement the ESOP with synthetic equity to "create incentive, a sense of ownership and pre-retirement liquidity." When developing a synthetic equity solution, it is imperative that the plan satisfy the IRC Section 409(p) Anti-Abuse Testing requirements. The article discusses the following synthetic equity solutions:

• Stock Options – "A stock option plan allows a company to grant to individual employees a contractual right, or option, to buy a certain number of the company's shares at any time during a specified time period (usually 10 years), paying a price that is specified at the time of the grant (usually fair market value at the time of the grant)."
  
• Stock Appreciation Rights (SARs) – "Stock appreciation rights, or SARs, are simply a contractual arrangement by which the company promises to make a cash payment to the individual at some point in the future, with the exact amount of money paid out to be determined by application of a formula tied to the appreciation in the value of the company's stock that occurs from the time the SARs are issued to the time that the payment is made."
  
• Equity-Based Deferred Compensation – "…a deferred compensation plan, in which managers give up some portion of their regular pay and, in exchange, are credited with "phantom stock units" that are held for them in a deferred compensation plan. Upon the conclusion of employment with the company, the individual would receive a cash payment equal to the number of phantom stock units credited to him multiplied by the current share price of the company's stock."

Three Points to Consider

1. Don't forget about the IRC Section 409(p) Anti-Abuse Testing requirements and the draconian penalties for noncompliance.
   
2. With any synthetic equity plan, make sure you are complying with the IRC Section 409A Nonqualified Deferred Compensation (NQDC) Plan Regulations.
   
3. Be aware of how Rangel's Corporate Tax Proposal would negatively impact the use of synthetic equity in certain ESOPs.

Applying LaRue to an ESOP Case, CASB Final Rule, and the U.S. Sugar ESOP

The June 2, 2008 Employee Ownership Update is online and discusses the following:

• District Court Says LaRue Does Not Apply in ESOP Case
• Cost Accounting Standards Board Finalizes ESOP Reimbursement Rules
• New York Times Article on U.S. Sugar ESOP Creates Controversy
• Ownership Thinking Conference Set for Denver September 17-18
  

The Update discusses Binita L. Cook et. al. v. Boyd F. Campbell, No. 2:01cv1425-ID (M.D. Ala., May 5, 2008), which ruled that an ESOP case could not be reopened based on the LaRue ruling:

In this case, the court had previously denied a claim by the plaintiffs concerning the alleged failure of the fiduciary of an ESOP at Central Alabama Home Health Services to provide for a proper valuation concerning the ESOP's purchase of shares. Now the plaintiffs sought reconsideration in light of LaRue. The court found, however, that even if the plaintiffs' allegations were valid, the actions of the fiduciary would affect the entire plan, not just individual participants. LaRue was premised on the difficulty a plaintiff might have in getting damages when the relief would apply only to that individual and a plan-wide remedy would thus be impractical or inequitable. Here, a plan-wide remedy was already available. Moreover, the court cited the concurring opinion of Chief Justice Roberts expressing concern that LaRue not be read to allow cases to proceed where existing administrative remedies had not been exhausted, as the court found they had not been in this case.

The Update also discusses Accounting for the Costs of ESOPs Sponsored by Government Contractors and the U.S. Sugar ESOP Issues.

Accounting for the Costs of ESOPs Sponsored by Government Contractors

The Cost Accounting Standards Board (CASB) is a function located within The Office of Federal Procurement Policy (OFPP) in the Office of Management and Budget:

Administratively a function located within OFPP is the Cost Accounting Standards Board (CASB), an independent legislatively-established board consisting of five members, including the OFPP Administrator, who serves as chairman, and four members with experience in Government contract cost accounting, two from the Federal government, one from industry, and one from the accounting profession. The Board has the exclusive authority to make, promulgate, and amend cost accounting standards and interpretations designed to achieve uniformity and consistency in the cost accounting practices governing the measurement, assignment, and allocation of costs to contracts with the United States.

Effective June 2, 2008, the CASB has adopted Cost Accounting Standards Board; Accounting for the Costs of Employee Stock Ownership Plans (ESOPs) Sponsored by Government Contractors:

The Cost Accounting Standards Board (the Board), Office of Federal Procurement Policy, has adopted a final rule to amend Cost Accounting Standard (CAS) 412, ''Cost Accounting Standard for composition and measurement of pension cost,'' and CAS 415, ''Accounting for the cost of deferred compensation.'' These amendments address issues concerning the recognition of the costs of Employee Stock Ownership Plans (ESOPs) under Government cost-based contracts and subcontracts. These amendments provide criteria for measuring the costs of ESOPs and their assignment to cost accounting periods. The allocation of a contractor's assigned ESOP costs to contracts and subcontracts is addressed in other Standards. The amendments also specify that accounting for the costs of ESOPs will be covered by the provisions of CAS 415, ''Accounting for the cost of deferred compensation,'' and not by any other Standard. This rulemaking is authorized pursuant to Section 26 of the Office of Federal Procurement Policy (OFPP) Act.

The June 2, 2008 Employee Ownership Update discusses the final rule:

On May 1, after many years of uncertainty, final rules were issued by the U.S. Cost Accounting Standards Board for reimbursing ESOP companies for contributions to their plans. The final rules are very favorable to companies. An "ESOP" is defined to include any defined contribution plan designed to invest primarily in employer stock. The reimbursement is for the market value of the shares at the time a contribution is made. The cost is assignable to a cost accounting period only to the extent an allocation is made to participant accounts by the tax return filing date, including any permissible extensions. For leveraged ESOPs, the allowability of the costs follows Federal Acquisition Regulation Part 31, which allows companies to charge the costs of principal and interest on an ESOP loan provided the stock is acquired at fair market value. Dividends are allowed as a cost. The regulation does not distinguish in this regard between S and C corporations. Companies operating under an existing approved reimbursement procedure can retain that method or renegotiate under the new rules.

UPDATE 6/7/08: Cost Accounting for Government Contractor ESOPs with Cost-Plus Contracts

The rules clarify cost recognition issues related to government contractor ESOP companies with cost-plus contracts:

Moreover, when the company is a government contractor with cost-plus contracts, certain ESOP costs are reimbursable to the extent there is room in the overhead of a contract. As a result, the costs associated with the ESOP can be reimbursed by the government to the company. The issue of which costs are reimbursable however, was both controversial and ambiguous prior to final rules adopted on May 1.

The actual amount of a dividend and/or contribution to a nonleveraged or leveraged ESOP (both principal and interest) are reimbursable costs and how "reimbursable costs for the applicable cost accounting period will only apply to the stock, cash, or combinations thereof that are awarded and allocated to employee accounts within that accounting period."

It also discusses how the final rules have eliminated the distinction between a pension ESOP and a deferred compensation ESOP for cost accounting purposes.

Related Links:

• 48 C.F.R. 52.230-2 Cost Accounting Standards

• Government Contractor ESOP Cost Accounting Rules Finalized

IRS Filings for Changing From C Corporation to an S Corporation

Filing Requirements for Filing Status Change provides guidance on the recommended steps to follow for making the election to change from a C Corporation to an S Corporation:

In an effort to more accurately receive and process returns from taxpayers who are requesting to change their filing status from a C Corporation (filing Form 1120) to an S Corporation (filing Form 1120S), the Internal Revenue Service recommends that taxpayers follow the steps below and use the following form.

Step 1. Timely file a paper copy of the Form 2553 with the appropriate Service Center as directed in the Form 2553 instructions. You may mail or fax this form.

Step 2. The corporation will receive an acknowledgement and approval of the S corporation election. If the notification of approval is not received, the corporation should follow-up with the Service Center where the Form 2553 was filed.

Step 3. File the last C Corporation return (Form 1120) by the due date or extended due date. Note: Some taxpayers are required to file electronically. For additional information on which Form 1120 filers are required to file electronically, please see T.D. 9363, I.R.B. 2007-49.

Step 4. File the S Corporation return (Form 1120S) by the due or extended due date. Note: Some taxpayers are required to file electronically. For additional information on which Form 1120S filers are required to file electronically, please see T.D. 9363, I.R.B. 2007-49.

The filing of the initial Form 1120S return will finalize the change of the entity's filing requirement on the Internal Revenue Service's records.

It also provides guidance for taxpayers who have not timely filed their election, both in the scenario where the Form 1120S has been timely filed for the first year of the intended S Corporation Election and where the Form 1120S has not been filed for the first year of the intended S Corporation Election.

Related Links:

• IRS Form 2553 – Election by a Small Business Corporation
• Instructions for IRS Form 2553 – Election by a Small Business Corporation

SPD Language Providing Less Plan Benefits Overrules Plan Document Language

In Conflict Between Plan Document and SPD, SPD Prevails to Participant’s Detriment discusses how Kolpacke v. CSX Pension Plan, No. 07-1959 (CA6, May 21, 2008) found that the SPD prevailed in a conflict between the plan document and the SPD, even if the SPD provided less benefits to the participant:

The SPD provided that the plaintiff's benefit under the plan would be reduced by railroad retirement benefits, which are the railroad industry's version of social security benefits. The participant argued that the plan document did not provide for this reduction in benefits, thus the conflict. Plaintiff also argued that CSX was estopped from reducing his benefits by an offset for railroad retirement because CSX provided him with a letter stating that his benefit had already been offset for railroad retirement and would be reduced no further. 9 days after the participant elected to retire, CSX corrected this mistake.

The district court granted summary judgment to CSX. Even though the benefit calculation made according the language in the SPD provided less benefits to the participant than the language in the plan document, the participant did not prevail. In the opinion, the district court cited to Anderson v. Chrysler Corp., 99 F.3d 846 (7th Cir. 1996) for the proposition that where the plan itself gives the employee greater benefits and protection, it should control.

The important takeaway is to make sure your plan document and SPD contain the same plan provisions.

We discussed this topic in detail in Conflicts Between the Plan Document and the Summary Plan Description (SPD), including discussions about the following:

• The plan document and the SPD are written at different times
• The plan document and the SPD are written in different styles
• The plan document and the SPD are written by different people
• Recent court cases provide that the SPD provisions and the interpretation of the provisions overrule the plan document if they benefit the participant
• Recent court case indicates absence of language in the SPD is not fatal if language is in other plan documents
• Do participants even read the SPD?
• How do you resolve a conflict?
• What is a way to minimize the risk of errors?

Qualified Default Investment Alternatives (QDIA) Modifications and Clarifications

DOL FAB Addresses QDIA Issues discusses Field Assistance Bulletin No. 2008-03 – Guidance Regarding Qualified Default Investment Alternatives (29 CFR § 2550.404c-5):

• Employer Fee Payment During 90-Day "No Fee" Period. While the regulations protect the participant from fees, employers are not prohibited from paying them.
  
• 90-Day "No Fee" Period Inapplicable to "Existing" Assets of Current Participants.
  
• No Prohibition on "Round-trip" Restrictions.
  
• 120-Day Capital Preservation QDIA Option Only Available for EACA.
  
• QDIA Notice May be Combined with Traditional Safe Harbor. It may also be combined with a QACA notice. The notice requirement is NOT satisfied by putting it in the SPD.
  
• Detail Regarding QDIA Notice Fee Disclosures. The regulations require an initial notice and an annual notice.
  
• Limited Regulatory Changes. For the most part, the FAB only reflects DOL interpretation of the regulations and does not actually change them. However, the article notes two modifications to the regulations:

  "First, the DOL modified the list of persons that may manage a QDIA to change one of the listed alternatives from the plan sponsor (i.e., the employer maintaining the plan) who is a named fiduciary of the plan, to "the plan sponsor, or a committee comprised primarily of employees of the plan sponsor, which is a named fiduciary within the meaning of [ERISA §402(a)(2)]." Second, the DOL modified the definition of stable value products or funds, for purpose of the "grandfathered" investment alternative permissible for default investments made before December 24, 2007, to provide that stable value products or funds must be designed to preserve principal and must invest primarily in investment products that are backed by state or federally regulated financial institutions, rather than requiring (as did the original final regulations) that the investment product be designed to guarantee principal and interest, and that a state or federally regulated financial institution guarantee the principal and the rate of return. Otherwise, the definition of the grandfathered investment remains the same as under the original final regulations."

IRC Section 409A Nonqualified Deferred Compensation (NQDC) Plan Regulations

Now’s the Time to Comply With NQDC Regs discusses IRC Section 409A and the related nonqualified deferred compensation (NQDC) plan regulations (see below for links to the regulations):

• What NQDC Is and Is Not
  
  • Distributions
  • Acceleration of benefits
  • Elections
    
    
• What's Covered – "The new rules apply to many common plans, including SERPs (supplemental executive retirement plans); certain SARs (stock appreciation rights); certain stock options; certain bonus and incentive deferral arrangements; certain severance arrangements; executive employment agreements that contain a deferral provision; certain split dollar life insurance; arrangements covering nonemployees such as directors; 457(f) plans; and other arrangements providing for the payment of compensation in the future. Some plans covered may not previously have been regarded as deferred compensation."
  
  
• Plethora of IRS Guidance (see below for details)
  
  
• Decisions for 2008
  
  
  • Payment elections - "You can make new elections regarding distributions dates and form during the transition period"
    
  • Linked payments – "The ability to link a payment election under an NQDC plan to an election under a qualified plan has been extended through 2008."
    
  • Grandfathering – "Clients also have to decide whether to preserve grandfather treatment for amounts deferred before 2005."
    
    
• More Regulation to Come? - "If I'm planning on making any changes in deferred compensation, I would try to do it earlier in the year rather than later"

If the Plan does not meet certain requirements, then some or all of the income deferred under the plan may become includible in gross income in the year of the failure. An additional 20% excise tax may also be imposed. The most important thing is to determine who is subject to 409A, as "the majority of the corporate agreements involved with professionals have provisions for accelerating or delaying payments, which can all trigger 409A issues."

History of 409A Regulations

Section 885 of the American Jobs Creation Act of 2004 (AJCA) added IRC Section 409A - Inclusion in gross income of deferred compensation under nonqualified deferred compensation plans, which provides that all amounts deferred under a NQDC plan for all taxable years are currently includible in gross income unless certain requirements are satisfied, to the Code:

Section 409A provides new and comprehensive rules governing NQDC arrangements. More specifically, § 409A provides that all amounts deferred under a NQDC plan for all taxable years are currently includible in gross income (to the extent not subject to a substantial risk of forfeiture and not previously included in gross income), unless certain requirements are satisfied. Section 409A is effective with respect to amounts deferred in taxable years beginning after December 31, 2004. It also is effective with respect to amounts deferred in taxable years beginning before January 1, 2005, but only if the plan under which the deferral is made is materially modified after October 3, 2004. In other words, § 409A may implicate exams starting with the 2004 audit cycle. If § 409A requires an amount to be included in gross income, the statute imposes a substantial additional tax. Employers must withhold income tax on any amount includible in gross income under § 409A. Section 409A also provides that deferrals under a NQDC plan must be reported separately on Form W-2 and Form 1099, as applicable.

• The requirements were provided in IRS Notice 2005–1 - Guidance Under § 409A of the Internal Revenue Code. Portions of this Notice were replaced by the Final Regulations.
  
  
• The IRC Section 409A Final Regulations - Treasury Regulation (TD 9321) - Application of Section 409A to Nonqualified Deferred Compensation Plans were issued on April 10, 2007, detailed in Nonqualified Deferred Compensation: Transition to Final Regulations, and effective for tax years beginning after 2007.
  
  
• Notice 2007-78 - 2008 Transition Relief and Additional Guidance on the Application of § 409A to Nonqualified Deferred Compensation Plans extended the document compliance deadline for one year and provided additional limited transition relief.
  
  
• IRS Notice 2007-86 - Notice of Additional 2008 Transition Relief under Section 409A extended the effective date of the final regulations through the end of 2008.
  
  
• IRS Notice 2007-100 - Transition Relief and Guidance on Corrections of Certain Failures of a Nonqualified Deferred Compensation Plan to Comply with § 409A(a) in Operation established the Nascent Voluntary Correction Program, which is a limited corrections program for inadvertent operational violations.
  
  
• IRS Notice 2007-89 - Reporting and Wage Withholding Under Internal Revenue Code § 409A is an extension to the 2007 tax years of the 2005 and 2006 tax year guidance provided under IRS Notice 2006-100 - Reporting and Wage Withholding Under Internal Revenue Code § 409A. It "provides guidance to employers and payers on their reporting and wage withholding requirements for calendar year 2007 with respect to amounts includible in gross income under § 409A of the Internal Revenue Code."

NQDC Audit Technique Guides

Corporate Executive Compliance contains links to audit technique guides (ATGs), including one for NQDC Plans, which agents use during the course of corporation and/or executive employee tax examinations.

Qualified Default Investment Alternatives (QDIA) Corrections and Additional Guidance

DOL Issues Guidance on Qualified Default