Plan Amendment Deadline

Extended

The IRS has extended the deadline for amending qualified retirement plans to satisfy, the provisions of TRA 86 and other legislation until the end of the 1993 plan year. Although TRA 86 provisions for plans generally, became effective as of the 1989 plan year, employers sponsoring qualified retirement plans that have not yet amended their plans for compliance now have until the end of the 1993 plan year (rather than the end of the 1992 plan year) to make retroactive plan amendments. The IRS has also extended the effective date of the final nondiscrimination regulations until the first day of the 1993 plan year. Nevertheless, employers should review their plans if they wish to make design changes to comply with TRA 86 before benefits accrue and contributions become required for the 1992 plan year.

Final Regulations

for Sec. 401(k) Plans

Plan Restructuring. The IRS has released final regulations governing qualified Sec. 401(k) cash or deferred arrangements, employee contributions, and matching contributions under qualified retirement plans. Effective as of the 1992 plan year, qualified plans may no longer be restructured for purposes of applying the actual deferral percentage test ("ADP Test") for employee contributions or the Sec. 401(m) actual contribution percentage test ("ACP Test") for employer matching contributions.

For plan years commencing before 1992, qualified plans may continue to be restructured based upon employee groups for purposes of applying these tests,

Collectively Bargained Plans. For plan years beginning on or after January 1, 1993, collectively bargained Sec. 401(k) plans will need to pass the ADP Test to secure pre-tax treatment of employee contributions.

Allocating Income. Employers may use any reasonable method for allocating income to excess deferrals, excess contributions or excess aggregate contributions. Employee contributions under a Sec. 401(k) plan exceeding the limits on contributions to qualified plans (i.e., the lesser of 25% of compensation or $30,000) may be distributed to avoid disqualification of the plan containing the Sec. 401(k) arrangement.

Hardship Distributions. The hardship distribution rules have been modified to permit the distribution of amounts necessary to pay taxes or penalties in connection with the hardship distribution. Further, distributions because of hardship may be made for the payment of tuition and related educational expenses for up to 12 months of post-secondary education (rather than just for the text term). Qualified plans max, be amended to modify, or otherwise eliminate a hardship distribution provision without violating the long-standing federal rule precluding a cut-back in benefits, only by, plan amendments made by the end of 1992.

Compensation. The final and proposed regulations issued in 1988 provide that, for purposes of applying the ADP and ACP Tests, a plan must take into account compensation for the full plan year, even if a participant was only eligible to participate for part of the plan year. The final regulations modify the definition of compensation for purposes of the ADP and ACP Tests by permitting a plan to count compensation earned during an employee's period of eligibility rather than for the entire plan year. Thus, for example, compensation for a half-year would take into account an employee becoming eligible on July 1 of a calendar year plan.

Contingent Benefit Rule. A Sec. 40 1 (k) plan will not be qualified if any other benefits (other than matching contributions) are contingent employee contributions. However, the final regulations, provide that deferred compensation under a non-qualified plan will not violate the aforementioned rule merely because it is dependent upon the employee making the maximum contribution under a Sec. 401(k) plan. This rule is intended to permit a non-qualified plan to provide benefits in excess of the elective dollar deferral limit (i.e., $8,728 in 1992), and will not cause a Sec. 401(k) plan to violate the so-called contingent benefit rule.

Excise Tax. Employers are subject to a 10% excise tax on any excess contributions or excess aggregate contributions that are not distributed or otherwise corrected within two and a half months following the end of the plan year. Prior regulations provided that the excise tax was payable with the employer's tax return for the taxable year in which the plan year ends, requiring payment within two and a half months after the end of the plan year (i.e., March 15 for a calendar year). This time frame required employers, in some instances, to pay the excise tax before the correction period had ended. Thus, the final regulations extend the due date for payment of the 10% excise tax until the last day of the fifteenth month after the close of the plan year in which the excess contributions or excess aggregate contributions arise (i.e., March 31 for a calendar plan year).

Corrective distributions made within two and a half months after a plan year are generally includible in income on the earliest late any employee contributions would have been received by the employee had he or she originally elected cash. Under a special de minimis rule enacted by the TAMRA 88, if the total amount of excess contributions and excess aggregate contributions (without income) is less than $100, a corrective distribution of excess contributions and income is includible in the recipient's income in the year of distribution, even if made within the two and a half month period. Distributions after the two and a half month period are includible in income in the year distributed with the employer then being liable for a 10% tax on excess contributions (but not income). If amounts are distributed after the end of the applicable 12-month period, the Sec. 401(k) arrangement is disqualified for the plan year for which the excess contributions are made and all subsequent plan years during which the excess contributions remain in the plan's trust.

Partnership Cash or

Deferred Arrangements

Waiving Participation. The final regulations provide that an arrangement that directly or indirectly allows individual partners to vary, the amount of the contributions made on their behalf is a Sec. 401(k) cash or deferred arrangement, and thus must meet the requirements of a Sec. 401(k) arrangement. Thus, any plan that permits partners to elect not to participate or to have a smaller amount contributed on their behalf would be treated as a Sec. 401(k) arrangement. Failure to satisfy the Sec. 401(k) requirements would cause these partner contributions to be taxable in the x,ear in which they were contributed to the plan. Nevertheless, partners may make a onetime irrevocable election to have a specified amount (or no amount) contributed to the plan on their behalf upon commencement of employment or upon initial eligibility under the plan. There is a transitional rule that would permit partners to make said election after commencement of employment or after initial eligibility, thereby permitting the employer to comply during the remedial amendment period.

Matching Contributions. The regulations have the effect of treating all matching contributions on behalf of partners as elective employee contributions. That is, employee contributions made by partners as well as matching contributions made by the partnership for partners under a Sec. 401(k) plan will both be treated as elective contributions and thus subject to the Sec. 401(k) dollar limit (which is $8,728 in 1992). Whereas common law employees may generally contribute $8,728 on a pre- tax basis, and receive allocations of matching employer contributions beyond the Sec. 401(k) dollar limit (up to the lesser of 25% of compensation or $30,000).

The preamble to the proposed regulations indicates this treatment was unintended and resulted from the interaction of plan qualification and partnership deductibility, rules. These deductibility rules require that a partnership allocate the deduction for all contributions to a defined contribution plan for a partner to the individual partner, making it impossible to treat a Sec. 401(k) matching contribution as anything other than an employee contribution. Thus, the final regulations retain the rule as in the proposed regulations pending further study by the Treasury Department to determine how to allow partnerships to have matching contributions without having them treated as employee contributions. In the meantime, any matching contributions made on behalf of partners will be treated as employee contributions, effectively prohibiting matching contributions to partners at this time.

Timing of Partners' Deferral Elections. The final regulations require partners to make deferral elections with respect to contributions on or before the last day of the partnership year. Nevertheless, in recognition of prior practice, the regulations apply this rule prospectively to plan years beginning on or after January 1, 1992. For prior plan years, a plan may permit partners to make deferral elections until the due date, including extensions, for filing the partnership's return. This rule is rather harsh in not allowing deferral elections after the last day of the partnership year since, although a partner is taxable on partnership income as of the last day of the year, the exact amount of such income is usually unknown. For example, any partner elections to defer from partnership income (under a Sec. 401(k) arrangement) for the partnership year ending December 31, 1992, must be made on or before December 31, 1992.