Taxpayers have through 12/31/2007 to bring nonqualified deferred compensation plans into compliance with respect to rules under IRC §409A(b) relating to offshore trusts and financial health triggers, under transition relief announced by the IRS. [IRS Notice 2006-33]
IRC §409A(b) requires income inclusion and additional taxation if an offshore trust is used in conjunction with a nonqualified deferred compensation plan or if assets become restricted upon a change in the employer’s financial health. The Gulf Opportunity Zone Act of 2005 (GOZA) §403(hh) clarified the effective date for IRC §409A(b) to be 1/1/2005, including amounts relating to compensation deferrals earned and vested on or before 12/31/2004. As further directed by GOZA, the IRS has provided a limited transition period for plans to come into compliance with §409A(b) –
- Definition of Nonqualified Deferred Compensation – The definitions under 409A(a) apply for purposes of compliance with 409A(b).
- Grace Period Assets – With respect to the provisions of §409A(b), “grace period assets” are assets set aside, transferred, or restricted on or before 3/21/2006, including actual earnings credited on such assets after 3/21/2006. Subsequent setting aside, transfer, or restriction of such assets will not be eligible for the transition relief.
- Compliance Transition Relief – With respect to grace period assets, the income inclusion and additional taxation provisions of IRC §409A(b) will not be triggered if the plan comes into compliance on or before 12/31/2007.
- Pre-2008 Payments – Payment of nonqualified deferred compensation through 12/31/2007 will be treated as having first been made from grace period assets. Payments included in income before 2008 will be treated as having complied with 409A(b) for pre-payment periods.
- Pre-2008 Disassociation – If grace period assets are no longer associated with payment of nonqualified deferred compensation on or before 12/31/2007 (for instance, through dissolution of a trust), then the plan is treated as having complied with 409A(b) through the date of the disassociation.
- Good Faith Compliance – Until further guidance has been published by the IRS, taxpayers may rely on reasonable, good faith interpretation of IRC §409A(b).
The Gulf Opportunity Zone Act of 2005 [GOZA; P.L. 109-135 (12/22/05); H.R. 4440] — providing relief for victims of 2005 hurricanes Katrina, Rita, and Wilma — includes special temporary distribution rules for hurricane victims, plus unrelated technical corrections relating to Roth designation of tax sheltered annuity deferrals, the definition of “dependent” for health savings accounts and dependent care spending arrangements, and rules for nonqualified deferred compensation under IRC §409A.
Retirement Plans – Distribution Relief [IRC §1400Q, as added by GOZA §201]
- Qualified Hurricane Distributions - GOZA expands distribution relief originally provided under the Katrina Emergency Tax Relief Act of 2005 to any “qualified hurricane distribution,” now defined to include distributions relating to Hurricanes Katrina, Rita, or Wilma. [IRC §1400Q(a)(4)]
- Hurricane Katrina – Any distribution from an eligible retirement plan made on or after 8/25/05 and no later than 12/31/06 to an individual whose principal residence on 8/28/05 is located in the Katrina disaster area and who has sustained an economic loss from Katrina.
- Hurricane Rita – Any distribution (other than a qualified hurricane distribution on account of Katrina) from an eligible retirement plan made on or after 9/23/05 and no later than 12/31/06 to an individual whose principal residence on 9/23/05 is located in the Rita disaster area and who has sustained an economic loss from Rita.
- Hurricane Wilma – Any distribution (other than a qualified hurricane distribution on account of Katrina or Rita) from an eligible retirement plan made on or after 10/23/05 and no later than 12/31/06 to an individual whose principal residence on 10/23/05 is located in the Wilma disaster area and who has sustained an economic loss from Wilma.
- Ceiling – The total amount of qualified hurricane distributions that an individual may receive from all plans, annuities, and IRAs is $100,000. [IRC §1400Q(a)(2)(A)] A retirement plan is not treated as violating the statute if a distribution is treated as a qualified hurricane distribution, provided the aggregate amount of all such distributions from all plans maintained by the employer’s controlled group to the individual does not exceed $100,000. [IRC §1400Q(a)(2)(B)]
- Eligible Retirement Plan – For purposes of qualified hurricane distributions, eligible retirement plans are as described in IRC §402(c)(8)(B). [IRC §1400Q(a)(4)(B)]
- Tax-Favored Treatment of Qualified Hurricane Distributions –
- Exemption from Premature Distribution Excise Tax – A qualified hurricane distribution is exempt from the 10% excise tax on premature distributions otherwise imposed under IRC §72(t). [IRC §1400Q(a)(1)]
- 3-Year Spreading of Ordinary Income Tax – Although exempt from the premature distribution excise tax, a qualified hurricane distribution remains subject to ordinary income tax. Taxable portions of the distribution are included in income ratably over 3 years, beginning with the taxable year in which the distribution was received. The individual may elect against application of 3-year spreading, including taxable amounts of the distribution in income entirely in the taxable year of the distribution.[IRC §1400Q(a)(5)]
- Repayment of Qualified Hurricane Distribution – Within 3 years following receipt of a qualified hurricane distribution, the individual is permitted to make one or more contributions up to an aggregate amount equal to the distribution to an eligible retirement plan. The plan must be one that accepts rollover contributions, and the individual must be a participant of the plan. The contribution is treated as having been received in an eligible rollover distribution and has having been transferred to the plan in a direct trustee-to-trustee transfer. [IRC §1400Q(a)(3)] Note – Presumably the individual would seek a refund of any taxes paid with respect to inclusion of distribution amounts in taxable income, as discussed above.
- Additional Rules applicable to Qualified Hurricane Distributions -
- Exemption from Withholding and Trustee-to-Trustee Transfer Rules. [IRC §1400Q(a)(5)(A)]
- Treated as Meeting Plan Distribution Requirements. [IRC §1400Q(a)(5)(B)]
- Recontributions of Withdrawals for Home Purchases – If an individual received an eligible distribution within a specified period before one of the hurricanes, if the distribution was meant to be used to purchase or contruct a principal residence within the disaster area, but then if that residence was not purchased or constructed because of the hurricane, then the individual may recontribute the distribution to an eligible retirement plan, thereby avoiding the otherwise applicable tax consequences for the distribution. The recontribution may only be made to a plan that accepts rollover contributions; and the indivdiual must be a participant in that plan. The recontribution must be received by the plan no later than 2/28/06. [IRC §1400Q(b)] Distributions qualifying for this relief are those that were received by the individual after 2/28/05 and -
- Katrina – Received before 8/29/05.
- Rita – Received before 9/24/05.
- Wilma – Received before 10/24/05.
- Relaxation of Loan Rules – For eligible plan loans made by hurricane victims, loan ceilings are doubled and repayment deadlines are extended for a year. [IRC §1400Q(c)]
- Increase in Loan Limits – For an eligible plan loan, the $50,000 ceiling is increased to $100,000; and the 50% account value limit is increased to 100%. To be eligible for the increased ceilings, the loan must be made during the applicable period -
- Katrina – 9/24/05 through 12/31/06.
- Rita – GOZA enactment (12/22/05) through 12/31/06.
- Wilma – GOZA enactment (12/22/05) through 12/31/06.
- Delay of Loan Repayment – For a hurricane viction with an outstanding plan loan on or after the qualified beginning date, any loan payment due date from that date through 12/31/06 is delayed 1 year. All subsequent payments are to be adjusted to reflect that delay, including any interest accruing during the delay. Qualified beginning dates for this purpose -
- Katrina – 8/25/05.
- Rita – 9/23/05.
- Wilma – 10/23/05.
- Plan Amendments – Plan amendments may be adopted as late as the close of the last day of the plan year beginning on or after 1/1/07, provided the plan has been operated in accordance with the provisions adopted. [IRC §1400Q(d)]
Inclusion of Roth Contributions in Application of TSA Cumulative Limit – Tax-sheltered annuity deferrals that have been designated as Roght contributions are taken into account in applying the $15,000 cumulative limit for additional elective deferrals. [GOZA §407, amending EGTRRA §617]
Uniform Definition of Dependent – Conforming amendments to the definition are made for purposes of health savings accounts, the dependent care credit, and dependent care assistance programs. An individual may qualify as a dependent for those purposes regardless of gross income that exceeds an otherwise applicable gross income limitation or on account of marriage with joint tax filing status. Such individuals are not subject to the general rule treating a dependent as having no dependents. [GOZA §404, amending WFTRA §§201, 203, 207]
IRC §409A Changes [GOZA §403(hh), amending AJCA §885]
- Additional tax and interest under IRC §409A are not treated as payment of regular tax for purposes of the alternative minimum tax.
- Application of the rule requiring additional deferrals to be made for a period of at least 5 years is not limited to the initial payment for which the deferral is made.
- Treasury guidance providing a limited period during which plans may comply with IRC §409A applies only for plans adopted before 1/1/05.
- The effective ate of funding provisions relating to offshore trusts and financial triggers is 1/1/05.
See also Technical Explanation of the Revenue Provisions of H.R. 4440, the “Gulf Opportunity Zone Act of 2005″ as Passed by the House of Representatives and the Senate, Joint Committee on Taxation, JCX-88-05 (12/16/05)]