IRS Proposes Rules for Public-Sector and Tax-Exempt Entity Deferred Comp Plans

The IRS on June 21 issued proposed regulations prescribing rules for taxing compensation deferred under 457 plans established and maintained by state or local governments or other tax-exempt organizations. These proposed regulations include rules for determining:

• when amounts deferred under these plans are includible in income;

• the amounts that are includible in income; and

• the types of plans that are not subject to these rules.

Highlights

The proposed regulations provide:

• general rules for determining the present value of compensation deferred under an ineligible plan, as well as specific rules for determining the present value of compensation deferred under ineligible plans that are account balance plans;

• specific rules for calculating the present value of compensation deferred under an ineligible plan that is an account balance plan; and

• rules regarding the conditions that constitute a substantial risk of forfeiture for purposes of Section 457(f).

They also provide that:

• contributions and withdrawals of a participant’s designated Roth contributions must be credited and debited to a designated Roth account maintained for the participant, and that the plan must maintain a record of each participant’s investment in the contract with respect to the account;

• no forfeitures may be allocated to a designated Roth account and that no contributions other than designated Roth contributions and rollover contributions described in Internal Revenue Code Section 402A(c)(3)(A) may be made to the account;

• distributions from an eligible governmental plan meeting the requirements of Internal Revenue Code Section 402(l) are excluded from gross income and are not subject to the general rule providing that amounts deferred under an eligible governmental plan are includable in the gross income of a participant or beneficiary for the taxable year in which they are paid;

• a plan must meet certain requirements to be a bona fide severance pay plan that is treated under Internal Revenue Code Section 457(e)(11)(A)(i) as not providing for the deferral of compensation;

• an employee’s voluntary severance from employment may be treated as an involuntary severance from employment for purposes of Section 457 if the severance from employment is for good reason;

• a safe harbor under which a plan providing for the payment of amounts upon a voluntary severance from employment under certain conditions, that are specified in writing by the time the legally binding right to the payment arises, will be treated as providing for a payment upon a severance from employment for good reason;

• the involuntary severance from employment requirement does not apply to window programs;

• the involuntary severance from employment requirement does not apply to an applicable voluntary early retirement incentive plan described in Section 457(e)(11)(D)(ii);

• a bona fide death benefit plan, which is treated as not providing for the deferral of compensation under Section 457(e)(11)(A)(i), is a plan providing for death benefits as defined in §31.3121(v)(2)-1(b)(4)(iv)(C);

• benefits under a bona fide death benefit plan may be provided through insurance and that any lifetime benefits payable under the plan that may be includible in gross income will not be treated as including the value of any term life insurance coverage provided under the plan;

• a bona fide disability pay plan, which is treated as not providing for the deferral of compensation under Section 457(e)(11)(A)(i), is a plan that pays benefits only in the event of a participant’s disability;

• if a plan of an eligible employer provides for a deferral of compensation for the benefit of a participant or beneficiary and the plan is not an eligible plan, the compensation deferred under the plan is includible in the gross income of the participant or beneficiary under Section 457(f)(1)(A) under certain conditions;

• any earnings credited thereafter on compensation that was included in gross income under Section 457(f)(1)(A) are includible in the gross income of a participant or beneficiary when paid or made available to the participant or beneficiary and are taxable under Internal Revenue Code Section 72;

• if a participant includes an amount of deferred compensation in income under Section 457(f)(1)(A), under certain conditions the participant is entitled to a deduction for the taxable year in which any remaining right to the amount is permanently forfeited under the plan’s terms or otherwise permanently lost;

• an amount of compensation deferred under a plan that provides for the deferral of compensation does not cease to be an amount subject to Section 457(f) due to any change to the plan that would recharacterize the right to the amount as a right that does not provide for the deferral of compensation;

• a deferral of compensation does not occur regarding any amount that would be a short-term deferral under Treas. Reg. §1.409A-1(b)(4); and

• compensation is not considered to be subject to a substantial risk of forfeiture merely because it would be forfeited if the employee accepts a position with a competing employer unless certain conditions are satisfied.

The proposed regulations amend:

• Treas. Reg. §§1.457-4(a) and (b) to reflect the change made that allows an eligible governmental plan to include a qualified Roth contribution program under which designated Roth contributions are included in income in the year of deferral;

• Treas. Reg. §1.457-7(b)(1) to specify that qualified distributions from a designated Roth account are excluded from gross income;

• the rules for the taxation of eligible governmental plan distributions under Treas. Reg. §1.457-7(b) to reflect the change made by the Pension Protection Act of 2006 regarding certain amounts distributed to an eligible public safety officer;

• Treas. Reg. §1.457-2(f) to implement the requirements of Internal Revenue Code Section 457(g)(4), which was added by the HEART Act and which provides that an eligible governmental plan must meet the requirements of Internal Revenue Code Section 401(a)(37); and

• the definition of plan to remove provisions identifying plans that are not subject to Section 457 and plans that are treated as not providing for a deferral of compensation.

The proposed regulations also:

• state that if a plan provides that entitlement to an amount is conditioned on an involuntary severance from employment without cause, the right is subject to a substantial risk of forfeiture if the possibility of forfeiture is substantial;

• address the interaction of the rules under Section 457(f) and Internal Revenue Code Section 409A;

• set forth rules for calculating the present value of compensation deferred under an ineligible plan that is not an account balance plan; and

• require that benefits under a bona fide severance pay plan be payable only upon an involuntary severance from employment or pursuant to a window or voluntary early retirement incentive program.

Comments Invited

The Treasury Department and the IRS request comments on all aspects of the proposed rules. Comments may be sent in the following ways:

• A signed original and eight copies can be sent to: CC:PA:LPD:PR (REG-147196-07), room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington DC, 20044.

• Submissions may be hand delivered Monday-Friday, 8:00 a.m.-4:00 p.m., to CC:PA:LPD:PR (REG-147196-07), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington DC, 20224.

• Submissions may be sent electronically via the federal eRulemaking portal at http://www.regulations.gov (IRS REG-147196-07).

Public Hearing

A public hearing has been scheduled for Oct. 18, 2016, beginning at 10:00 a.m. in the auditorium at the IRS building at 1111 Constitution Avenue, NW, Washington, D.C.