American Benefits Council
Benefits Byte

2014-088

September 18, 2014

The Benefits Byte is the American Benefits Council’s regular e-mail and online newsletter for members only, providing timely reports on legislative, regulatory and judicial developments, along with updates on the Council’s activities in support of employer-sponsored benefit plans.

The Benefits Byte is published by the American Benefits Council, based on staff reports and edited by Jason Hammersla, Council director of communications. Contact information for Council staff related to specific topics can be found at the end of each story.

Click here to read past issues on the Benefits Byte Archive page.

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New Summary Available: 40% Excise Tax on High-Cost Health Coverage

Now available on the Council website for members only is a Benefits Blueprint reviewing the statutory requirements on the 40 percent excise tax imposed on high-cost health coverage under the Patient Protection and Affordable Care Act (PPACA). A companion document, with answers to certain “Frequently Asked Questions” regarding the excise tax, is also now available on the Council website.

The excise tax is a nondeductible 40 percent excise tax created under Internal Revenue Code (IRC) Section 4980I, as added by PPACA. The tax applies to “applicable employer-sponsored coverage” in excess of statutory thresholds (in 2018, $10,200 for self-only, $27,500 for family). The tax was implemented as a “revenue raiser” to pay for other aspects of the PPACA, including federal subsidies for coverage for low-income individuals, and also to address perceived over-consumption of health care coverage.

Although the tax is not scheduled to be implemented until 2018 and implementing regulations have not yet been issued, employers will want to assess how the tax affects their plans and consider approaches to escape incurring it.

The Blueprint, prepared by Groom Law Group, Chartered, covers the following questions in detail:

  • To what coverage does the excise tax apply? The tax applies to “applicable employer-sponsored coverage”, or coverage under any group health plan made available to the employee by an employer which is excludable from the employee’s gross income under Code Section 106, or would be so excludable if it were employer-provided coverage (within the meaning of Code Section 106). The term encompasses insured and self-funded plans, and it also includes both employer- and employee-paid coverage. It also applies to governmental plans and coverage providing health insurance to a self-employed individual. 
  • How is the excise tax determined? The excise tax is equal to 40 percent of the aggregate value of applicable employer-sponsored coverage that exceeds a specified annual limitation. The tax is triggered for a calendar year if there is an “excess benefit,” determined on a monthly basis, with respect to applicable employer-sponsored coverage at any time during the calendar year.
  • How much is the annual limitation? The annual limitation will vary from year to year depending on a number of factors. For 2018, the base dollar threshold is (i) $10,200 for self-only coverage, and (ii) $27,500 for coverage other than self-only coverage, but these base limits will be adjusted by a variety of factors.
  • Who pays the tax? The sponsoring employer is required to determine the total amount of the excise tax and allocate the amount among those entities liable for paying the tax. Code Section 4980I provides that the health insurance issuer, the employer and the administrator of plan benefits are all liable for paying the portion of the tax attributable to its share of the coverage. The statutory language makes clear that the excise tax is a nondeductible tax. 
  • What are the penalties for failing to properly calculate and/or pay the excise tax? If an employer does not accurately calculate the portion of the excess benefit and, as a result, a provider pays insufficient tax, the provider must pay the amount of the additional tax, and the employer will have to pay a penalty equal to 100 percent of the missed portion of the Excise Tax that was underpaid by the provider due to the miscalculation. The employer must also pay underpayment interest.

Working with the Administration and Congress to lessen the impact of the excise tax on employers remains a top priority for the Council. For more information, contact Katy Spangler, senior vice president, health policy, or Kathryn Wilber, senior counsel, health policy, at (202) 289-6700.



Treasury, IRS Release Long-Awaited Rules on Hybrid Retirement Plans

The U.S. Treasury Department and Internal Revenue Service (IRS) released long-awaited final rules addressing market rate of return for hybrid retirement plans (i.e., plans, such as cash balance plans and pension equity plans, that are defined benefit plans, but are structured in certain ways like defined contribution plans) under the Pension Protection Act of 2006 (PPA).

The final rules generally apply to plan years that begin on or after January 1, 2016, though the portions of the rules that merely clarify the 2010 final rules apply to plan years that begin on or after January 1, 2011, in accordance with the effective date rules of the 2010 final rules. Along with these final regulations, IRS also issued proposed transitional amendments for hybrid plans that are not in compliance with the final rules.

The newly released final regulations provide guidance on certain issues that were not covered by the final regulations issued in October 2010. The Council (along with the Coalition to Preserve the Defined Benefit System) provided comments on the proposed version of these regulations in January 2011, followed by substantial written and in-person outreach with Treasury officials including a supplemental joint submission on hybrid plan issues, as well as a letter raising certain issues with respect to the proposed regulations and detailed answers to specific questions posed by these officials.

The Council has consistently argued that hybrid retirement plans represent the most promising and innovative element of the defined benefit pension system. The Council is studying the final regulations and will soon schedule a Benefits Briefing webinar to go over the final and proposed rules. In the meantime, here is a preliminary summary of some of the key issues that the Council has advocated for:

  • Effective date: The Council has repeatedly emphasized the need for a delayed effective date of at least 12 months. We were very pleased with the final rules in this regard.
  • Transition rules: The Council has also asked for clear workable transition rules that are proposed and subject to public comment before they are finalized. We were very pleased that the transition rules have been issued in proposed form and provide paths to compliance for plans that do not currently comply with the market rate of return rules. We look forward to member comments on the workability of these transition rules. 
  • Compliance prior to regulatory effective date: On numerous occasions, the Council has asked that plans that have been complying with a reasonable interpretation of the market rate of return rule be deemed to be in compliance for the period between the statutory effective date (generally plan years beginning on or after January 1, 2008) and the regulatory effective date. The concern has been that there would be an inference that the final or proposed regulations were the only means to comply during this period. The preamble to the final regulations does not provide the rule  requested by the Council but does clarify that no such inference is intended. 
  • Market rate of return in general: We have long believed that any rate of return available in the market should generally be treated as a market rate of return. Unfortunately, the final rules retain a limited list of rates of return that can be market rates. So even if a rate of return not listed in the final rules is available in the market (such as an investment available under a company’s 401(k) plan) and is lower in one or more years than an approved rate of return, the plan will be treated as violating the market rate of return rules. 
  • Maximum fixed rate of return: The proposed regulations did not permit a fixed rate of return in excess of 5 percent. We asked that this be increased to 6 percent, which was done. 
  • Maximum permitted minimum rate of return: In the case of plans that credit interest at the higher of a variable bond-based rate (such as one of the segment rates) or a minimum rate, the proposed regulations did not permit the minimum rate to exceed 4 percent. We asked that the 4 percent be raised to 5 percent. This was done for all bond-based rates other than the segment rates, for which the 4 percent rule was retained. 
  • Whipsaw: The proposed regulations imposed conditions on the elimination of whipsaw and generally prohibited hybrid plans from providing subsidized benefits, such as subsidized joint and survivor annuities or subsidized early retirement benefits. The final rules addressed many of the concerns raised by the Council but we are continuing to review this part of the final rules and invite member input. 
  • Participant directed interest crediting rates: Treasury and the IRS are continuing to study whether a hybrid plan may permit participants to choose their interest crediting rate among a menu of possible rates (similar in effect to the arrangements that are common under a 401(k) plan). If Treasury and the IRS conclude that such designs are not permissible, Treasury and the IRS anticipate that plans that have participant-directed interest crediting rates as of the date the final rules are published in the Federal Register will have anti-cutback relief to eliminate this impermissible feature. The implication is that plans that first make this feature available in the future will not receive such anti-cutback relief and thus will face qualification issues. 
  • Backloading: The proposed regulations included a special rule with respect to the application of the 133? percent backloading rule. The backloading rules limit the rate of accrual for later years of service relative to earlier years of service. The premise of the special rule, as reflected expressly in the preamble to the final rules, is that if a plan uses an investment-based rate of return, the actual rate of return for the prior year must be used to project benefits to normal retirement age for purposes of determining satisfaction of the backloading rules. In the view of the government, this is and has always been the rule. In the proposed regulations, Treasury and the IRS recognized that this could cause widespread problems satisfying the rules in the year after an investment rate of return was negative. So the proposed regulations offered “relief” by permitting plans in such a situation to project forward to normal retirement age assuming a zero rate of return. 
  • The Council pointed out that there is no statutory basis for projecting forward at last year’s rate of return; for example, if an S&P 500 fund lost 7 percent in a prior year, then under the premise of the government’s position, the plan would be assuming that the S&P 500 fund would lose 7 percent per year for the next forty-something years, which is difficult to support either technically or conceptually. And assuming that the S&P 500 fund earns a zero return for the next forty-something years is similarly hard to support. We continue to argue that the right answer – both technically and conceptually – is to project forward at a reasonable long-term rate of return. 
  • Unfortunately, the final rules retained the rule in the proposed regulations. This will clearly cause at least one problem and perhaps many more. 
  • If a cash balance plan provides pay credits that increase with age and/or service and provides an investment-based rate of return that can be negative for a year, then the plan may well have difficulty passing the 133? backloading test. 
  • Projecting cash balance plan benefits forward to normal retirement age is necessary for many other purposes under the law. If this same flawed system is applied, cash balance plans with an investment rate of return could have very serious problems. 
  • Many more issues of significance: The final rules include many more very significant rules, which the Council will discuss in its Benefits Briefing webinar. 

IRS is accepting comments on the proposed transitional amendments through December 18 and will hold a public hearing on January 9 to discuss suggested modifications.

For more information or to provide input, contact Lynn Dudley, senior vice president, global retirement and compensation policy, or Jan Jacobson, senior counsel, retirement policy, at (202) 289-6700.



IRS Releases Guidance on Roth Accounts, After-Tax Allocations

On September 18, the U.S. Treasury Department and Internal Revenue Service (IRS) released Notice 2014-54and proposed regulations generally allowing taxpayers to choose how to split after-tax contributions between traditional and Roth Individual Retirement Accounts (IRAs) whenever after-tax and pre-tax amounts are simultaneously disbursed to multiple destinations. This will allow pre-tax contributions to be rolled to a traditional IRA and after-tax contributions to a Roth IRA, regardless of whether the distribution is a direct rollover or 60-day rollover.

Under the previously issued Notice 2009-68, a distribution which includes a direct rollover and cash to the participant or a distribution split between two IRAs resulted in the after-tax contributions being allocated pro-rata between the two portions of the distribution, while a 60-day (indirect) rollover resulted in taxable amounts being allocated first to the rolled over portion. The direct rollover treatment precluded participants from receiving all of their after-tax contributions in cash while directly rolling over the taxable portion to an IRA. It also prevented participants from separating out after-tax contributions to roll over to a separate Roth IRA. (See the June 1, 2010, Benefits Byte for more details.)

The newly proposed rules apply to distributions made on or after January 1, 2015, but taxpayers can choose an earlier applicability date so long as that date is on or after September 18, 2014 (the date the new guidance became available to the public). The pro-rata allocation of after-tax contributions contained in the Roth regulations (which the proposed regulation amends) will apply to distributions from designated Roth accounts prior to the applicability date.

The Council actively sought resolution of the split distribution issue through communications with IRS and Treasury officials, including two letters in October 2009 and again in June 2010, as well as with numerous conversations with IRS and Treasury officials.

Section III of the notice, which also applies to distributions from 403(b) and 457(b) governmental plans, provides detailed guidance on the allocation of after-tax and pre-tax amounts along with examples. If a direct rollover is made of only a portion of the benefit, the pre-tax contributions will be applied first to that amount. If pre-tax contributions remain after that allocation, they will next be allocated to any 60-day rollovers (up to the total amount of the 60-day rollovers) and if the remaining pre-tax amount is less than the 60-day rollovers, the taxpayer can designate how the pre-tax amount is allocated among the plans that receive 60-day rollovers. If pre-tax amounts remain after allocation to all of the rollovers, that amount is includible in the taxpayer’s income.

Plans using the IRS’s model 402(f) notice (the notice provided to participants on distribution of benefits) will need to use a modified version that eliminates the “pro-rata” language applied to split distributions. This and other issues will be addressed in a Council’s comment letter to IRS.

Comments and requests for a public hearing will be accepted through December 18, 2014. For more information or to provide input on a comment letter or hearing request, contact Jan Jacobson, senior counsel, retirement policy, at (202) 289-6700.



The American Benefits Council is the national trade association for companies concerned about federal legislation and regulations affecting all aspects of the employee benefits system. The Council's members represent the entire spectrum of the private employee benefits community and either sponsor directly or administer retirement and health plans covering more than 100 million Americans.

Notice: the information contained herein is general in nature. It is not, and should not be construed as, accounting, consulting, legal or tax advice or opinion provided by the American Benefits Council or any of its employees. As required by the IRS, we inform you that any information contained herein was not intended or written to be used or referred to, and cannot be used or referred to (i) for the purpose of avoiding penalties under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party any transaction or matter addressed herein (and any attachment).