United States: Administration’s budget proposals tighten rules for 409A violations, VEBA funding and compensation health plans
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On March 28, the Biden administration presented its fiscal year 2023 budget proposals reflecting its fiscal and tax policy priorities, which may surface when Congress resumes work on fiscal reconciliation. While it’s hard to gauge Congress’ appetite for tackling tax increases at this point, the package proposes the following major changes:
- increase in the top rate for companies from 21% to 28%,
- increase in the top tax rate from 37% to 39.6%, and
- a minimum income tax of 20% for households worth more than $100 million.
In addition to these high-profile tax proposals, the accompanying 120-page Treasury “Green Paper” includes three proposals potentially affecting the funding of post-retirement benefits, penalties for violations of Section 409A of the Tax Code (“Code”) and tax treatment. flat-rate health insurance policies. We briefly comment on these proposals – all of which would be effective for tax years after 2022 – below.
A. Withholding Tax on 409A Non-Qualified Deferred Compensation (“NQDC”) Violations
Section 409A of the Code imposes complex rules on the deferral and payment of nonqualified deferred compensation. Violations of the rules result in the imposition of an additional 20% tax and interest on affected employees.
While the green paper does not change the 409A rules themselves, the proposal would require employers to withhold the additional 20% income tax and tax on additional NQDC interest included in an employee’s income. employee as a result of a violation of 409A. As a result, IRS agents would have an easier time collecting 409A penalties when violations are identified during a corporate tax audit. Under current law, penalties are imposed on affected employees, which requires coordination with other parts of the IRS and no withholding is required.
Unfortunately, the Treasury and IRS have not yet issued final regulations on how to calculate income inclusion for 409A violations, so this proposal will prove difficult for affected taxpayers. Still, congressional markers believe imposing a withholding requirement on employers should improve compliance — according to the Joint Committee on Taxation’s revenue table, this proposal is expected to bring in nearly $7 billion over a budget period. 10 years old.
B. Strengthen the rules for financing post-retirement benefits
The Code’s long-standing rules limit employers’ ability to pre-fund retiree health and life insurance benefits to a period based on “the working life of covered employees, actuarially determined on a uniform basis “. The IRS has not issued any guidance on this determination, however. In its 2003 decision in Wells Fargo v. Commissioner, the Tax Court allowed a current deduction for the full amount needed to fund the liabilities of workers already in retirement. 120 TC 69. Many employers relied on this decision to pre-fund retiree medical benefits into VEBAs and insurance continuation funds.
The Green Paper includes a proposal that would generally limit the pre-funding of retiree benefits to the longer of (1) the working life of covered employees or (2) 10 years, unless the employer undertakes to maintain the same level of benefits for 10 years. years. As a result, an employer could no longer pre-fund all of the liabilities of already retired employees in a single year on a currently deductible basis.
In support of the proposition, the general explanation (on page 108) states the following:
there is no specific prohibition on using funds that are no longer needed to provide post-retirement benefits to provide other social benefits instead. Therefore, an employer can effectively accelerate deductions for social benefits provided to current employees by making a lump sum contribution to a reserve for future retiree benefits in a year, eliminating or reducing those retiree benefits, and then , in subsequent years, directing these funds towards the cost of social benefits for current employees.
This explanation ignores the fact that an employer’s ability to change its retiree benefit provisions is regulated by ERISA and has been the subject of much litigation. Additionally, while there is no specific prohibition, the IRS currently has a “no rule” policy on an employer’s ability to “reallocate” retiree surplus medical assets to pay other employee benefits, such as medical care for active employees, without subjecting the employer to the reversionary excise tax of Code Section 4976.
C. Clarifying the Taxation of Lump Sum Medical Policies
Some employers offer their employees insured fixed benefit benefits that pay fixed amounts for a specified medical event rather than benefits based on the actual cost of medical care.
The Green Paper proposes to clarify that the exclusion under section 105(b) of the Code for fixed indemnity policy payments is limited to actual medical expenses, and any excess benefit beyond these amounts is a “salary” included in the employee’s income and subject to standard payroll deduction provisions. However, the proposal would not affect the treatment of benefits under policies purchased with after-tax employee money.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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