THE TAXPAYER RELIEF ACT OF 1997 AND COMPLIANCE DATES

By David Langer, David Langer
Company, Inc.

The complex Taxpayer Relief Act of 1997 was enacted on August 5, 1997. Summarized below are a number of welcome changes to qualified retirement plans and to IRAs.

Qualified Plan Distributions

* Cashout Limit. The $3,500 limit above which a participant's (and in some plans spouse's) consent to a distribution is required is increased to $5,000. This allows plans to remove more small amounts from recordkeeping requirements and PBGC premiums--effective for plan years beginning after July 31, 1997.

* Repeal of 15% Excess Tax. The 15% excise tax applicable to total annual plan distributions that exceed $160,000 (or total lump sum payments that exceed $800,000 and that are taxed using forward averaging) is eliminated retroactive to January 1, 1997.

* Post-Tax Employee Contributions. A new table, for use with joint and survivor annuities that begin after 1997, extends the period for recovery of mandatory post-tax employee contributions.

* Rollover Relief. A plan will not be disqualified for having accepted a rollover from another plan that did not have an IRS determination letter.

Employee Communications

* SPD/SMM. As of August 5, 1997, there is no longer a requirement to file Summary Plan Descriptions or Summary of Material Modifications with the Department of Labor, although they must still be provided to employees and sent to DOL, if requested.

* Electronic Transactions. IRS and DOL are to issue guidance by the end of 1998 to take into account the automation of employee elections, notices, and disclosures by many plans and on how paperless transactions may comply with "written" requirements. A recent IRS guidance letter provided that an employee's signature was not required for a 401(k) plan loan; this can reduce the time for getting a loan and some recordkeeping.

Deductible Contribution

* Contribution Limitation Raised. The deductable limit on contributions to defined benefit plans, currently 150% of current liability, will be gradually increased beginning in 1999 plan years to 170% for plan years beginning in 2005. This will allow more plans to make larger deductible contributions without imposing the 10% excise tax on contributions that exceed the limit. In addition, the amounts that could not be contributed due to such limit are amortized over 20 years, compared to 10 years before the change.

About half of defined benefit plans are currently up against the limit, which hampers their ability to prefund future benefits in an orderly fashion and could lead to large cost increases in later years. The increase in the limit will be most beneficial to recently adopted plans and plans with young participants, which have small current accrued benefits and liabilities and are therefore more likely to have contributions limited under this provision. Companies that might otherwise not establish defined benefit plans because of the contribution limit may now be encouraged to do so.

* Combined Plan Limit. If an employer sponsors two or more plans, there is an overall limit on the total deductable contributions to such plans of 25% of total compensation, subject to the minimum funding requirements of any defined benefit plan. Any contributions in excess of 25% are subject to a 10% penalty. This was expanded in 1994 to allow 401(k) deferrals of up to six percent of compensation to be excluded from the penalty. It is now further expanded to provide that the total of 401(k) deferrals and matching contributions can also be excluded from the 10% penalty.

Example: A company's defined benefit plan contribution is 15% of pay, its profit sharing plan contribution is 10%, its 401(k) contributions are six percent of pay, and its matches are three percent of pay. Prior to 1994, everything over 25% (nine percent of pay) would be subject to the 10% excise tax. After 1994, the three percent match would be subject to the tax, but the six percent 401(k) contributions would not. Now, however, the total of nine percent of 40l(k) and matching contributions are not subject to the tax.

* Self-Employment. Matching contributions on behalf of self-employed individuals will no longer be considered additional elective 401(k) contributions; these reduced the 401(k) contribution or match that could be made by such persons.

IRAs (Effective January 1, 1998)

* Deductible IRA. The act increases over a 10-year period the adjusted gross income limits that currently prevent or reduce IRA contributions by employees earning over the limits (currently phased out beginning at $40,000 for married and $25,000 for single) and participating in an employer sponsored qualified plan. The new phaseout levels will ultimately be $80,000 for married and $50,000 for singles. Spousal IRAs are expanded by allowing a spouse who is not covered by an employer sponsored plan to make IRA contributions up to $2,000 subject to a phaseout if adjusted gross income exceeds $150,000 if filing jointly, or $95,000 if filing single.

Withdrawals prior to age 59!s be made without penalty for college or vocational education of the taxpayer, spouse, children, and grandchildren and for first time home buyer expenses up to $10,000.

However, since IRA earnings are taxed as ordinary income when withdrawn, the drop in the capital gains tax, and the new Roth IRA described below, in which taxes on earnings can be avoided, may make other savings alternatives more attractive.

* New Roth IRA. Individuals may make nondeductable IRA contributions of up to $2,000 (less any other IRA contributions), phased out for income over $150,000 if filing jointly, or $95,000 if filing single. If held for at least five years, income earned will not be taxable when distributed, nor will the distribution be subject to early withdrawal penalties, provided the distribution is made either after age 59!s, upon death or disability, or to meet up to $10,000 in expenses for first time home buyers. Persons with adjusted gross income less than $100,000 can change their current IRAs to Roth IRAs, but the current balance becomes taxable income that can be spread over a four-year period starting in 1998. Thereafter, the investment earnings will not be taxable when paid, if withdrawn as described above.

Miscellaneous

* Employer Securities. Effective January 1, 1999, no more than 10% of a 401(k) plan's assets may be invested in employer securities where the plan requires that a portion of employee's contributions be invested in such securities. Alternatively, a plan can restrict the required investment in employer securities to one percent of employee's salary. The restrictions do not apply to ESOPs.

* Anti-Alienation Exception. Generally, benefits cannot be paid except to the participant, a beneficiary, or under a qualified domestic relations order. Now, benefits can be reduced to satisfy ERISA civil judgments, losses resulting from crimes committed with respect to the plan by the participant, and settlements of fiduciary violations between the participant and the DOL or PBGC.

* Prohibited Transactions. The excise tax on prohibited transactions in a qualified plan or ERA is increased to 15% from 10% as of August 5, 1997.

* Self-Employed Health Insurance. Forty percent of health insurance costs of self-employed individuals are deductible in 1997. This will increase to 100% by 2007.

* Not Passed. The following two provisions were dropped from the final bill: the required spousal consent for lump sum distributions from 401(k) plans and a safe harbor classification of independent contractors.

Compliance Dates

Under the new legislation and some recent laws, such as the Small Business Job Protection Act of 1996 (SBJPA) and the Uruguay Round Agreements Act (GATT), portions are effective at different dates up to the year 2000, and do not require immediate amendment, even if put into effect by the employer. The IRS issued a revenue procedure reiterating that most plans must be amended for those provisions by the last day of the plan year beginning in 1999 (despite there being many outstanding matters requiring guidance). Provisions effective at later dates, such as the elimination of the IRC section 415(e) combined limitation, can be adopted prospectively
at the same time, but will not have retroactive effect.

The anti-cutback rule still applies, unless expressly exempted (e.g., for certain
GATT changes and, after final rules are
published, to eliminate benefit commencement to active participants at age 70!s). In addition, the revenue procedure specifically allows the elimination of
family aggregation rules to be effective retroactively when the final amendments are made.

The 1999 date includes any amendment under SBJPA to repeal any earlier amendment to change the assumptions used under IRC section 4l5 that had been required by GATT and which were later deferred by SBJPA. Such date also coincides with the extended reliance period that had been available to plans that had been timely submitted under the Tax Reform Act of 1984.

IRS eventually will publish procedures for obtaining determination letters under SBJPA and GATT, which, hopefully, will be coordinated with the changes under the Taxpayer Relief Act of 1997. *