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New Legislation Includes Changes to Existing Pension, Taxation Provisions

Washington, DC, March 19, 2002 - The “Job Creation and Worker Assistance Act of 2002” (H.R. 3090), which was signed into law by President Bush on March 9, 2002, includes a number of provisions affecting retirement plan service providers, regulated investment companies (RICs), and their shareholders. In particular, the Act:

The Joint Committee on Taxation has prepared a technical explanation of the Act.

Technical Corrections to EGTRRA
The technical corrections to EGTRRA are generally effective as if they had been included in the provisions of EGTRRA.

Deemed IRAs. EGTRRA provided that if an eligible retirement plan permits employees to make voluntary employee contributions to a separate account or annuity that meets the requirements applicable to traditional IRAs or Roth IRAs (and certain other requirements), the separate account is deemed to be a traditional IRA or Roth IRA. The Act clarifies that for purposes of a “deemed IRA,” the term “qualified employer plan” includes the following types of plans maintained by a governmental employer: a qualified plan under Code section 401(a), a qualified annuity plan under section 403(a), a 403(b) plan, and an eligible deferred compensation plan under 457(b). The Act also clarifies that ERISA is intended to apply to deemed IRAs in a manner similar to SEPs.

Benefit and Contribution Increases. Because of the benefit and contribution limit increases enacted by EGTRRA, a new “base period” applies in indexing the 2002 dollar amounts for certain future cost-of-living adjustments. The Act makes conforming changes to the limits set forth in Code sections 408(k) and 409(o) in order for future indexing to operate properly.

Top-Heavy Rules and the Same-Desk Rule. EGTRRA repealed the “same desk” rule and made certain modifications to the top-heavy rules applicable to retirement plans. The Act clarifies that distributions made after severance from employment are considered for only one year in determining top-heavy status under a plan.

SEP Deduction Limits. EGTRRA increased the Code section 404(h)(1) annual limitation on the amount of deductible contributions that can be made to a SEP from 15 percent of compensation to 25 percent. The Act makes a conforming change (from 15 percent to 25 percent) to Code section 402(h)(2)(A)—the provision that limits the amount of SEP contributions that may be made for a particular employee.

Notably, the Joint Committee’s explanation regarding this provision states that the Treasury Secretary, under present law, has the authority to require an employer making contributions to a SEP to provide simplified reports for such contributions, and that reports could include information on compliance with the SEP requirements, including the contribution limits for SEPs.

In addition, the Act clarifies that elective deferrals made to SEPs are not subject to the deduction limits and are not taken into account in applying the limits to other SEP contributions.

Combined Deduction Limit. The Act clarifies that the combined deduction limit of 25 percent of compensation for defined benefit and defined contribution plans does not apply if the only amounts contributed to the defined contribution plan are elective deferrals.

Nonrefundable Credit for Contributions to Plans and IRAs. EGTRRA established a nonrefundable tax credit for elective contributions made by eligible taxpayers to certain employer-sponsored retirement plans and IRAs. The Act provides that the amount of contributions taken into account to determine the credit for such contributions is reduced by the amount of distributions from the plan or IRA that is included in income or that consists of after-tax contributions. Rollover distributions or trustee-to-trustee transfers to another retirement plan do not affect the credit.

Credit for Small Plan Start-Up Costs. EGTRRA provided a nonrefundable tax credit for certain plan-related expenses of a small employer that adopts a new qualified defined benefit plan, defined contribution plan, SIMPLE plan, SEP, or payroll deduction IRA program. The Act clarifies that this tax credit applies in the case of a plan first effective after December 31, 2001, even if adopted on or before that date.

Catch-Up Contributions. EGTRRA permitted catch-up contributions to be made by individuals age 50 or over to retirement plans. The Act makes a number of changes to the rules that govern catch-up contributions. In particular, the Act:

  • clarifies that the applicable catch-up limit applies to all qualified retirement plans, tax-sheltered annuity plans, SEPs, and SIMPLE plans maintained by the same employer on an aggregated basis, as if all plans were a single plan; the Act also clarifies that the limit applies to all eligible deferred compensation plans of a government employer on an aggregated basis;
  • provides that the total amount that an individual may exclude from income as catch-up contributions for a year cannot exceed the catch-up limit for that year, without regard to whether the individual made catch-up contributions under plans maintained by more than one employer;
  • provides that an individual who will attain age 50 by the end of the taxable year is a catch-up eligible individual;
  • clarifies that a participant in an eligible 457 plan of a government employer may make catch-up contributions in an amount equal to the greater of the amount “regular” catch-up contribution and the amount permitted under the special catch-up rule for eligible 457 plans; and
  • clarifies that catch-up contributions can only be made to qualified defined contribution plans, not defined benefit plans, and incorporates the “transition period” for mergers and acquisitions.

Equitable Treatment for Contributions to Defined Contribution Plans. The Act clarifies that the contribution limits governing 403(b) plans apply in the year the contributions are made, without regard to when the contributions become vested. The Act also provides that contributions to a 403(b) plan may be made for an employee for up to five years after retirement, based on the includible compensation for the last year of service before retirement. Additionally, the Act restores special rules for ministers, employees of churches, and foreign missionaries that were inadvertently eliminated from the Code.

Definition of Compensation for 457 Plans. The Act conforms the definition of “includable compensation” in Code section 457(e)(5) (applicable to 457 plans) to the section 415(c)(3) definition of compensation (applicable to defined contribution plans).

Rollovers of After-Tax Contributions. EGTRRA expanded the portability of retirement assets by, among other things, allowing the rollover of after-tax contributions under certain circumstances. The Act clarifies that only a “qualified trust” which is part of a defined contribution plan or a traditional IRA may receive after-tax amounts by direct rollover.

In addition, the Act provides an ordering rule for rollovers from plans with after-tax amounts. Specifically, if a distribution includes both pre-tax and after-tax assets, the portion of the distribution that is rolled over is treated as consisting first of pre-tax amounts.

Disregarding Rollovers for Purposes of Cash-Out Amounts. EGTRRA permitted plans to disregard rollover amounts when determining the present value of a participant’s accrued benefit for purposes of making involuntary “cash-out” distributions from the plan. The Act clarifies that rollover amounts may be disregarded also in determining whether a spouse must consent to the cash-out benefit.

Defined Benefit Plan Provisions. In addition to those noted above, the Act contains other technical corrections applicable only to defined benefit plans. These include changes with regard to (1) the notice of significant reduction in plan benefit required by EGTRRA and (2) the timing rules for plan valuations. The Act’s nontechnical correction provisions relating to defined benefit plans include those relating to (1) the interest rate used in determining additional required contributions; and (2) PBGC premiums applicable to defined benefit plans.

ESOP Dividends. EGTRRA expanded the deductibility of dividends in ESOPs. The Act provides that (1) a reinvested dividend in qualifying employer securities at the participant’s election must be nonforfeitable, and (2) the deduction for dividends reinvested in qualifying employer securities at the election of participants is allowable for the taxable year in which the later of the reinvestment or the election occurs.

Electronic Delivery of IRS Forms 1099
The Act removes statutory impediments (i.e., first-class mailing requirements) to electronic delivery of tax information returns under certain enumerated Code sections, including IRS Forms 1099-DIV and 1099-INT. For this purpose, a recipient must consent to electronic delivery of the covered forms in a manner similar to the one permitted for purposes of electronic delivery of IRS Form W-2 or in such other manner as provided by the IRS. The Joint Committee on Taxation’s technical explanation notes that, under present law, the IRS has authority to issue rules under which IRS Forms 5498 and 1099-R may be provided to taxpayers electronically. The provision is effective on date of enactment.

Taxation of Securities Futures Contracts
The Act makes three changes to the taxation of securities futures contracts, as initially provided by the “Community Renewal Tax Relief Act of 2000” (CRTRA). Each of these changes are effective as if included in the CRTA.

Sale, Exchange, or Termination of Securities Futures Contracts. CRTRA subjects dealer securities futures contracts to taxation. Under CRTRA, gain or loss from the cancellation, lapse, expiration, or other termination of a nondealer securities futures contract was treated as a capital gain or loss under the Code. However, gain or loss from the sale or exchange of a securities futures contract was determined by reference to the underlying property to which the contract relates under the Code. The Act eliminates this potentially disparate treatment of terminations and dispositions by (1) removing securities futures contracts from the Code, and (2) expanding the Code to cover the “sale, exchange, or termination” of securities futures contracts.

Short Sale Treatment. The Act includes provisions expressly to provide that entering into a securities futures contract to sell will be considered a short sale and that settlement of such a contract will be considered the closing of a short sale.

Application of Wash Sale Rules. The Act revises the Code expressly to provide that losses realized on the sale, exchange, or termination of a nondealer securities futures contract to sell are subject to the wash sale rules.