Some employers automatically enroll every employee in their health insurance plan and pay the entire cost of employee coverage, unless the employee elects out of insurance coverage. In some cases, employees who can prove that they have alternative health insurance coverage may elect out of the employer’s health insurance plan and receive increased pay in lieu of health insurance. Under federal tax laws, this practice is safe only in the context of a section 125 cafeteria plan.

The IRS has recently taken the position that this practice can cause tax qualification problems for the employer’s retirement plans. Your company is at risk if you answer yes to the following three questions:

1. Does your company’s retirement plan definition of compensation include employee pre-tax contributions to a Section 125 cafeteria plan?
   

2. Does your company require employees to certify that they have alternative insurance coverage to receive cash in lieu of the company’s insurance coverage?
   

3. Does your company treat the employer-paid premium for individual coverage as Section 125 premium payments and include those amounts in the employee’s compensation for retirement plan purposes?

If you answered "yes" to each of those questions, the bad news is that the IRS takes the position that your company has been calculating compensation improperly under its retirement plan for employees who did not have alternative health insurance coverage. The good news is that, for a limited time, employers may correct this error through a simple retroactive plan amendment, with no burdensome administrative correction required. Since this simple IRS correction option expires at the end of the year, quick action is imperative.

CAUTION:  The need for this amendment will not be automatically resolved through the so-called GUST amendment and restatement of your plan document. You need to discuss this specific issue with your counsel and retirement plan document provider.

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North Carolina Passes EGTRRA Conforming Legislation

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The Job Creation and Worker Assistance Act of 2002

The Job Creation and Worker Assistance Act of 2002 ("JCWAA") was signed into law by President Bush on March 9, 2002. Although the bill was styled an Economic Stimulus Bill, it contains several technical corrections to the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), as well as temporary funding relief for defined benefit plans.

Some of JCWAA’s highlights are:

Catch Up Contributions: JCWAA provides some technical guidance on the administration of catch up contributions. Confirming the position taken by the IRS, JCWAA permits an individual to make a catch up contribution at any time during a tax year if he or she will turn 50 in that year. It clarifies the tax treatment of catch up contributions and provides some relief from the universal availability requirement for acquisitions. Finally, it caps the amount that can be deferred as a catch up contribution in a Section 457(b) plan. Under JCWAA, a Section 457(b) Plan participant may make a catch up contribution up to the greater of the limit under the old 457(b) rules or the limit under EGTRRA.

After-tax Ordering Rule: Under the prior rule for allocating after-tax money, if a participant split a distribution (kept part of the money and rolled part over), each part of the distribution would be considered to be a mix of after-tax and pre-tax money. For instance, if a participant requested a total distribution of $1,000 (with $200 after-tax basis), but directed that $800 be rolled over and $200 distributed to him directly, he would be taxed on a portion of the $200 since part of it would be considered to be pre-tax money.

Under the new rule, if a participant rolls over a portion of a distribution from a plan and the distribution includes after-tax contributions, the amounts rolled over will first be considered to come from pre-tax dollars. The effect of the rule is to allow a participant to roll over pre-tax money, keep after-tax contributions, and allocate the full after-tax basis to the after-tax contributions that he or she will take into income. Under the example above, this means that the $800 rollover will be considered pre-tax money only and the participant can apply the full $200 after-tax basis to the amount he kept.

Rollover Contributions Disregarded for Purposes of J&S Requirements: Plans subject to the joint and survivor annuity requirements for distributions may now ignore rollover amounts for purposes of determining if a plan balance is under $5,000.

Defined Benefit Funding Relief: In reaction to Treasury’s decision to stop issuing 30-year Treasury bonds, JCWAA allows large defined benefit plans subject to the additional funding requirement to determine their current unfunded liability for 2002 and 2003 using an interest rate within 90% to 120% (up from 105%) of the four-year weighted average of the 30-year Treasury bond. In addition, a plan may use 100% (rather than 85%) of the 30-year Treasury bond rate for the month preceding the month in which the plan year begins to determine the PBGC variable premium rate for the plan.

JCWAA Amendment Deadline:The funding relief provision is effective for plan years after December 31, 2001 and before January 1, 2004. The new funding rules do not require plan amendment unless the change conflicts with existing plan provisions. The technical corrections discussed above are subject to the same amendment deadline as the EGTRRA amendments.

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Final Rules on Electronic Disclosure and Recordkeeping

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Accounting Reform Legislation Includes Important New 
Retirement and Executive Compensation Rules

The Sarbanes-Oxley Act (the "Act"), signed into law by President Bush on July 30, 2002, contains some important provisions governing retirement and executive compensation programs. The Act imposes new requirements for administering blackout periods in 401(k), profit sharing and other individual account plans, increases sanctions for criminal violations of ERISA, and generally prohibits publicly traded corporations from making loans to executive officers or directors.

Regulating Blackout Periods

Starting January 26, 2003, 401(k) and other individual account plans will have to provide advance written or electronic notice to participants and beneficiaries of any "blackout period". Subject to limited exceptions, the Act defines a blackout period as any suspension or restriction of the right to direct investments or to obtain loans or distributions for a period of more than three consecutive business days.

In most cases, the plan administrator will have to provide the blackout notice at least 30 days before the beginning of the blackout period. However, the 30-day requirement does not apply if a plan fiduciary makes a written determination that delaying the blackout period would violate ERISA’s fiduciary standards, or that failure to provide 30 days advance notice results from unforeseeable circumstances or circumstances beyond the plan administrator’s control. The 30-day requirement also does not apply if the blackout is being imposed in connection with a merger or similar transaction involving the plan or the plan sponsor. When one of these exceptions to the 30-day rule applies, the plan administrator is required to provide the blackout notice as soon as reasonably possible.

Blackout notices must meet certain content requirements, and must be written in a manner that will be understood by the average participant. If the blackout period changes after the initial notice is provided, the plan administrator is required to provide notice of the changes.

The Act directs the U.S. Department of Labor to issue a model notice and regulatory guidance by January 1, 2003, and to issue interim rules by October 13, 2002.

The Department of Labor is authorized to impose a $100 per day, per recipient penalty for each failure by a plan administrator to comply with the new notice rules. In other words, if a plan administrator is required to provide notices to 90 participants and 10 beneficiaries, and provides the notice 10 days late, the Department of Labor could impose a $100,000 penalty.

Although the new rules do not go into effect until 2003, plan fiduciaries should consider following the new rules immediately.

If the plan holds employer securities and a blackout period restricts trading in those securities, the Act generally prohibits executive officers and directors from trading certain employer securities outside of the plan so long as the plan blackout remains in effect. The ban applies only to employer securities acquired by the executive officer or director in connection with his or her service or employment (for example, any securities acquired under the employer’s equity compensation programs). However, this insider trading ban does not apply to securities that are exempt from federal securities regulation, and the ban only applies when a plan blackout period limits the ability of at least half of the sponsor’s plan participants to trade employer securities.

The Act makes several changes that will affect public company compensation practices. Beginning July 30, 2002, public companies may not make direct or indirect loans to executive officers or directors, subject to certain limited exceptions. It appears that this provision will prohibit relocation loans, securities acquisition loans, and even split dollar life insurance arrangements. The Act does contain exceptions for certain consumer credit transactions by companies in that business, and for loans to executive officers and directors of FDIC-insured institutions (the latter category is subject to applicable rules under the Federal Reserve Act).

If a company is required to restate its financial statements because of "material noncompliance of the issuer", the chief executive officer and chief financial officer must refund to the issuer bonuses and incentive compensation received during the year after the original statements.

Increased Criminal Sanctions Under ERISA

Effective July 30, 2002, the Act increases the criminal sanctions for willful violations of ERISA. For individuals, the maximum criminal penalty is now a $100,000 fine and up to ten years in prison. For entities, the maximum penalty is now a $500,000 fine.

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