Wednesday, August 8, 2018


August 8, 2018

Summary: The availability of participant loans from tax-qualified retirement plans often results in increased Plan participation by non-highly compensated employees.  Employers often choose to make loans available from their plans as a matter of employee relations.  However, plan loans are subject to complicated rules under both ERISA and the Code, and they are a trap for the unwary if they are not administered properly in compliance with these rules.  Recent developments regarding participant loans include certain changes made by the Tax Cuts and Jobs Act of 2017 and other recent IRS guidance.  This article provides a roadmap for practitioners in advising clients on instituting and operating a participant loan program.
The ability of participants in qualified plans, especially § 401(k) plans, to obtain loans from such plans is responsible in no small way for the popularity of the plans and the increased participation of employees in such plans.  Plan loans, however, are subject to a very specific set of rules, which, if not followed, may subject such loans to income and penalty taxes.  Specifically, such loans must comply with the conditions set forth in § 408(b)(1) of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and § 72(p) of the Internal Revenue Code of 1986, as amended (Code).  If these conditions are not met, loans to plan participants may be prohibited transactions under ERISA, may violate the "anti-alienation" rules of ERISA and the Code and may be deemed to be taxable distributions to the participants who received the loans.  This article attempts to chart the course that must be followed so that unintended consequences are avoided.
Part I examines the prohibited transaction rules of ERISA § 408.  Part II examines the taxable distribution rules of Code § 72(p), as well as issues relating to deemed distributions and foreclosures.  Other miscellaneous issues are examined in Part III.

Loans from a plan to a participant are prohibited extensions of credit from the plan to a party in interest unless the requirements of the statutory exemption of ERISA § 408(b)(1) and Code § 4975(d)(1) are met.[1]  The requirements of Code § 4975(d)(1) must also be met in order that the loan not violate the anti-assignment rule of Code § 401(a)(13) and ERISA § 206(d).
The conditions of this statutory prohibited transaction exemption of ERISA § 408(b)(1) and Code § 4975(d)(1) are that the loans must:
(1)    be available to all participants and beneficiaries on a reasonably equivalent basis;
(2)    not be available to highly compensated employees in an amount greater than to other employees;
(3)    be made in accordance with the loan provisions set forth in the plan;
(4)    bear a reasonable rate of interest; and
(5)    be adequately secured.[2]
In addition, Department of Labor (DOL) regulations require that the loan program be legitimate.[3]

Requirement of Plan-Wide Availability on a Reasonably Equivalent Basis

General.  The loans must be available to all participants and beneficiaries on a reasonably equivalent basis.[4]  To meet this requirement, (1) the loans must be available without regard to race, religion, gender, etc.; (2) consideration must be given only to factors that would be considered in normal commercial circumstances by an entity in the business of making similar types of loans, including, for example, the creditworthiness and financial need of the applicant; and (3) the loans in actual practice must not be unreasonably withheld from any applicant.[5]

Availability May Be Limited to Parties in Interest.  The DOL takes the position that the plan-wide availability requirement is required only with respect to parties in interest, and that a plan may limit loans to parties in interest.[6]  Active employees of the sponsoring employer are all parties in interest.  Former employees are typically not parties in interest, but certain former employees by reason of some other relationship to the company or plan may be parties in interest.[7]  A plan could therefore not exclude all former participants where some are parties in interest.

A plan provision permitting loans is a benefit, right or feature subject to the nondiscriminatory availability test of Treas. Reg. § 1.401(a)(4)-4.  Most loan programs easily meet this rule for active employees.  However, because plan loans are only required to be made available to those former employees who are also parties in interest, the potential for discrimination with respect to former employees in favor of highly compensated former employees is greater.  In recognition of this problem, the § 401(a)(4) regulations provide that former employees who are parties in interest may be treated as active employees.[8]

Minimum Loan Amounts.  Minimum loan amounts of up to $1,000 may be established without violating the reasonably equivalent basis requirement.[9]

Other Restrictions Allowed.   A plan is allowed to limit the availability of loans to specific purposes such as hardship, college tuition, home purchases, etc., provided that loans continue to be made available to participants and beneficiaries on a reasonably equivalent basis.[10]

Loans to Particular Bargaining Unit Employees.  A plan whose participants are members in several unions and makes a loan feature available only as their collective bargaining agreements are renegotiated would not violate the reasonably equivalent requirement, if within a reasonable time period all bargaining units approve the loan feature.[11]

Prohibited Loans to Executive Officers Under Sarbanes Oxley Act.   The Sarbanes Oxley Act of 2002 prohibits loans to directors or executive officers.  There is no clear authority as to whether the Sarbanes Oxley Act of 2002 prohibition on loans to executive officers would apply to 401(k) plan loans, as extensions or arrangements of credit by the issuer.  A joint memo by 25 law firms "Interpretive Issues Under § 402 - Prohibition on Certain Insider Loans," (Oct. 15, 2002) argued that 401(k) loans should be permitted, since the officer is effectively borrowing from himself and the loan is from the plan rather than the issuer, but there has been no SEC guidance on the matter.  The DOL in a field assistant bulletin has held that possible restrictions on loans to officers and directors under the Sarbanes Oxley Act would not cause a plan to violate the reasonably equivalent basis rule for participant loans under ERISA § 408(b)(1)(A).[12]

Loan Fees.  The preamble to the DOL regulations makes it clear that fees may be charged to cover the administrative cost of making loans.[13]

Requirement That Loans Not Be More Available to Highly Compensated Employees than to Other Employees

The loans may not be available to highly compensated employees[14] in an amount greater than to other employees.[15]  To meet this requirement, it must be determined upon consideration of the facts and circumstances that the program does not operate to exclude large numbers of participants from receiving loans.  A loan program will not fail because it limits loans to a maximum dollar amount or to a maximum percentage of a participant's vested accrued benefit, despite the fact that under a percentage limit the maximum loan amount will vary with the size of the participant's accrued benefit.[16]

Requirement That the Plan Document Specifically Permit Loans

General.  The loans must be made in accordance with loan provisions set forth in the plan.[17]  Regulations provide that plan provisions must contain explicit authorization for the establishment of a loan program.[18]  In addition, the plan document or a written document forming part of the plan must include:  (1) the identity of the person or position authorized to administer the loan program; (2) a procedure for applying for loans; (3) the basis on which loans will be approved or denied; (4) limitations (if any) on the type of loans offered; (5) the procedure for determining a reasonable rate of interest; (6) the types of collateral that may secure the loan; and (7) the events constituting default and the steps that will be taken to preserve plan assets in the event of such default.[19]
Summary Plan Description (SPD).  The enumerated items described in the preceding paragraph affect the rights and obligations of participants and therefore must be set forth in a plan's SPD.[20]   The preamble to the final regulations notes that the SPD alone can satisfy the plan provision requirement if it contains the required loan provisions and is a document forming part of the plan.[21]

Loan Documentation.  Typically, loan documents will include the plan loan provisions (contained in the plan or SPD), loan application guidelines, a loan application, a loan disclosure statement, and a promissory note and security agreement.

Requirement of a Reasonable Interest Rate

General.  The loans must bear a reasonable rate of interest.[22]  To meet this requirement, the loan must provide the plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans that would be made under similar circumstances.[23]  A strict reading of the regulations may require different interest rates depending on each participant's creditworthiness.[24]  Thus, if local banks would lend the participant, taking into account his or her creditworthiness and the collateral offered, at a fixed rate of 12%, a plan that loaned at 8% would not be charging a reasonable rate of interest and would not be entitled to the relief provided by ERISA § 408(b)(1).[25]

State Usury Laws Not Relevant.  State usury laws may not be used to justify a low rate of interest.[26]

Rates of Interest Commonly Used.  Some courts have analyzed reasonable interest taking into account that the loan is a compensating balance loan with the loan secured by a sum of money deposited by the borrower with the lender, and therefore, according to expert testimony cited in one case, a rate of one or two percent above the certificate of deposit rate would be reasonable. [27]  Many plans have been charging the prime interest rate plus 1 or 2 percentage points.  However, because the prime rate in recent years has been low, IRS officials have indicated at a 2011 phone forum that prime plus 2 percent is currently what the IRS deems to be a reasonable rate of interest.[28]  Other plans charge the prevailing rate for home equity loans.

Rates for Loan Renewals.  When a loan is subject to renewal, the prevailing market rate at the time of renewal must be charged.[29]

Fixed Versus Adjustable Rates.  Most plans charge a fixed interest rate for the loan for administrative convenience, although adjustable rates are also permitted.

Requirement of Adequate Security

Security That Can Be Foreclosed With "No Loss."  The loans must be adequately secured.[30]  To meet this requirement, the security posted must be:  (1) something more than a mere promise to pay; (2) capable of being foreclosed on or otherwise disposed of in the event of default in an amount equal to the amount due; and (3) of such value and liquidity that it is reasonably anticipated that there will be no loss of principal or interest.[31]

Use of 50% of Participant's Vested Accrued Benefit as Security.  A participant's vested accrued benefit may be adequate security, but only up to 50% of such benefit may be so utilized.[32]

Spousal Consent.  Because foreclosure of a plan loan is treated as a distribution, spousal consent to waive the qualified joint and survivor annuity requirement, where applicable, must be obtained.  Spousal consent rules apply mainly to defined benefit plans (and money purchase pension plans).[33]  The spousal consent rules can be met by obtaining spousal consent to the loan and foreclosure not more than 90 days before the date the loan is made.[34]  The adequate security requirement of ERISA § 408(b)(1) may require that spousal consent be obtained at the time a loan is made from a plan subject to the spousal consent rules.[35]

Mortgage Loans. Code § 72(p)(3) provides that an interest deduction may not be taken with respect to a plan loan if it is:  (i) made to a key employee (as defined in Code § 416(i)), or (ii) secured by the participant's § 401(k) elective deferrals.  If a loan to a non-key employee is secured by the participant's principal residence (i.e., a mortgage) rather than by his or her § 401(k) account, the mortgage interest deduction would be allowed.[36]

In certain limited circumstances, plans that have investment programs making mortgages available to individuals including plan participants will not be subject to the limits of Code § 72(p) with respect to the participant loans.[37]

Source of Loan Proceeds.  Typically, participant loans from defined contribution plans are taken directly from the participant's account.  Often a special loan subaccount is created.[38]  The loan then becomes an investment of the individual account but not of the entire plan.  Under another method most commonly used by plans that do not have individual accounts, the participant borrows from the plan as a whole and, as the loan principal and interest are repaid, they accrue to the entire plan rather than to the participant's account.  The loan is then considered a general investment of the entire plan.

Impact of Source of Collateral on "No Loss" Rule.  Where a loan is treated as an investment attributable solely to the participant's account, the adequate security requirement will be met and the "no loss" rule satisfied even if the security interest cannot be immediately foreclosed on (e.g., because of "in-service distribution" restrictions).[39]  However, if the loan investment is allocated to the plan as a whole, the preamble to the 1989 DOL regulations states that the security of the accrued benefit may not be sufficient without some additional security, such as mandatory payroll deduction or discounting the value of the vested accrued benefit to take into account the time delay between any possible default and the first distributable event with respect to the borrowing participant's account.[40]

Legitimacy Requirement. 

DOL regulations provide that to meet the requirements of ERISA § 408(b), there must be a legitimate loan program that is administered by the fiduciary primarily in the interest of participants.[41]  The legitimacy of a loan program will be determined by consideration of all facts and circumstances.[42]  Where there is, for example, no intention that the loan be repaid by the participant, the loan is not exempt.  Likewise, a loan program designed to benefit a party in interest other than a participant is not exempt.[43]

Code § 72(p) Generally

Code § 72(p) provides that loans to participants or beneficiaries from a qualified plan (i.e., under Code §§ 401(a), 403(a), or 403(b)) will be treated as taxable distributions from the plan,[44] unless:
(1)    the loan does not exceed statutory dollar limit or percentage limit;
(2)    the loan requires repayment within 5 years (or a longer period if the loan is used to acquire a principal residence);
(3)    the loan requires substantially level amortization over its term; and
(4)    the loan is evidenced by a legally enforceable agreement in writing or acceptable electronic medium.[45]
Plans that May Offer Loans
Plans that may offer loans include: (i) qualified plans under Code § 401(a); (ii) Code § 403(a) and Code § 403(b) annuity plans; and (iii) governmental 457 plans.[46]  However, loans cannot be taken from Individual Retirement Accounts (IRAs) or Simple Employee Pensions (SEPs).
Requirement That the Loan Be Limited in Amount
General.  The statutory requirement is that the total of all outstanding loans of the participant from the plan[47] may not exceed the lesser of:
(i)  $50,000 reduced by the excess, if any, of (A) the highest outstanding balance of loans during the one-year period ending on the day before the date of the loan, over (B) the outstanding balance of loans from the plan on the date the loan is made;[48] or
(ii)  the greater of (A) one-half the present value of the participant's nonforfeitable accrued benefit, or (B) $10,000.[49]

$10,000 Minimum Not Typically Relevant.  Despite the statutory authority to do so, plans do not typically provide that a participant may borrow $10,000 regardless of the size of his or her nonforfeitable accrued benefit, because the ERISA adequate security requirement,[50] discussed in Part I above, precludes plans from considering more than 50% of the participant's vested accrued benefit as collateral, and would require additional collateral.  For example, a vested accrued benefit of $18,000 would not be adequate security for a $10,000 loan.

$50,000 Limit May Be Restated in Simpler Way.  The complex statutory formulation of the $50,000 prong of the loan limit may be more simply stated:  the maximum amount of any individual new loan is limited to $50,000 reduced by the highest outstanding balance of loan(s) during the one-year period before the new loan is made.[51]

For example, if the highest outstanding balance on prior plan loans of a participant during the preceding year is $25,000, and the outstanding balance of prior loans immediately before taking the new loan is $15,000, the maximum aggregate loan balance the participant may have (under the statutory formulation) cannot exceed $50,000 reduced by $10,000 (the excess of $25,000 over $15,000), or $40,000.  Since the $15,000 prior loan is still outstanding, the maximum new loan cannot exceed $25,000.  The same result is reached by simply limiting the new loan itself to $50,000 minus the highest outstanding loan balance during the preceding year ($50,000 minus $25,000).
The 50% of vested accrued benefit limit of Code § 72(p)(2)(A) must still be met on an aggregate basis for all loans from controlled group plans, and cannot be simplified in the above manner.

Loan Considered Outstanding for Maximum Permitted Amount After Deemed Distribution and Additional Security for Subsequent Loans.  For purposes of calculating the maximum permitted amount of a subsequent loan under Code § 72(p)(2)(A), a loan that has been deemed distributed under § 72(p) and has not been repaid (such as by plan loan offset) is still considered outstanding until the loan obligation has been satisfied for purposes of determining the maximum amount of any subsequent loan to the participant.[52]

As amended in December 2002, regulations provide that if a loan is deemed distributed to a participant and has not been repaid (such as by plan loan offset), then no payment made thereafter to the participant will be treated as a loan for purposes of § 72(p)(2), unless there is  an enforceable arrangement among the plan, participant, and employer, under which repayments will be made by payroll withholding or the plan receives adequate security in addition to the participant's accrued benefit for the additional loan. [53]

Frequency of Loans.  Some plans provide that no more than one loan may be outstanding at any time.  Others provide for waiting periods between loans.[54] 

Requirement That the Loan Be Repaid within Five Years

General.  A loan by its terms must require repayment within five years.[55]  If the loan is not required to be repaid within five years, it is an immediate taxable distribution.  In addition, if a loan providing for repayment over five years is not repaid during such period, the amount remaining payable at the end of the five years is a taxable distribution.[56]  If there are required periodic payments, the first of which is due to be made within two months of the date the loan was made, legislative history indicates that the five-year repayment period will be measured from the due date of that first payment, but some practitioners recommend amortization over 59 months in such cases.[57]

Principal Residence Loans.  Loans used to acquire a principal residence are an exception to the five-year repayment requirement.[58]  Nonetheless, plans typically do impose some limit on principal residence loans, such as 10, 15 or 20 years.  A principal residence loan that is for a significantly longer period than the period under commercially available loans (e.g., longer than 30 years) may not be permissible.[59]

A principal residence has the same meaning as under Code § 121 (relating to exclusion of gain from sale of principal residence).[60]  There is no requirement that it be a principal residence for any specific period of time.[61]  Tracing rules similar to those applicable under Code § 163(h)(3)(B) (relating to the deduction for home acquisition indebtedness) apply.[62]  Refinancings do not qualify as principal residence loans, although a plan loan that would otherwise qualify may be used to repay a bank loan.[63]

Requirement of Level Amortization

General.  Substantially level amortization over the term of the loan is required, and participants must make payments no less frequently than quarterly.[64]

Payroll Deductions and Written or Electronic Authorizations.  Most plans provide for loan repayment by payroll deduction. 

Some state wage-and-hour laws require that payroll deductions be in writing.  These laws, however, may be preempted by ERISA.  For example, a 1994 DOL Advisory Opinion held that a New York Law requiring written authorization for payroll deductions, is preempted by ERISA to the extent it prevents a plan from implementing a salary reduction arrangement by a telephone voice response system.[65]  Similarly, a 1996 DOL Advisory Opinion held that ERISA preempts a Puerto Rico law that allows authorized payroll deductions only for contributions to pension plans and not for loans.[66]
Cessation of Payments during Leave of Absence.  The level amortization requirement will not be violated if repayments cease while an employee is on a leave of absence for a period of up to one year.[67]  However, the loan (plus interest accruing during the leave of absence) must still be paid within the original five-year period, and therefore when the employee returns to work an accelerated payment schedule or a lump sum repayment at the end of the five year period would be necessary.[68]  If repayments cease while an employee is on a military leave of absence even for a period beyond one year as permitted under Code § 414(u)(4), the suspension will not cause the loan to be deemed distributed, as long as loan repayments resume upon the completion of the military service, the amount then remaining due on the loan is repaid in substantially level installments thereafter, and the loan is fully repaid by the latest permissible term of a loan (five years for a non-principal residence loan) plus the period of the military service.[69] 

Level Amortization in Loan Refinancings.  Regulations as added in 2002 provide that while a loan can be refinanced and additional amounts may be borrowed, the prior loan and additional loan must each satisfy the requirements in § 72(p)(2)(B) and (C) that each loan be repaid in level installments, not less often than quarterly, over five years.[70]  The loans collectively must satisfy the amount limitations of § 72(p)(2)(A).  A refinancing is, in effect, treated as a new loan that is then applied to repay a prior loan if the new loan both replaces a prior loan and has a later repayment date. This rule does not apply to a refinancing loan under which the amount of the prior loan is to be repaid by the original repayment date of the prior loan.[71]

Regulatory Requirement of an Enforceable Agreement in Writing or Electronically

The Treasury regulations impose an additional requirement in order to avoid a deemed distribution under Code § 72(p):  the loan must be evidenced by a legally enforceable agreement (which may include more than one document), and the terms of the agreement must demonstrate compliance with the requirements of Code § 72(p) (specifying the amount of the loan, the date of the loan and the repayment schedule in accordance with the rules of § 72(p)).[72]

Regulations issued in 2000 provide that the loan agreement must be in a written enforceable agreement or in an electronic medium reasonably accessible to the participant under a system (i) reasonably designed to preclude anyone other than the participant from requesting a loan, (ii) that provides a reasonable opportunity to review the terms of the loan and to confirm, modify or rescind the terms of the loan, and (iii) that provides a confirmation of the loan terms through a written document or an electronic medium.[73]  If an electronic medium is used to provide confirmation of the loan terms, it must be reasonably accessible and must be provided in a manner no less understandable than a written paper document.  Also, the participant must be advised of the right to receive a copy of the confirmation on a written document without charge.[74]  The regulations provide that the loan agreement does not have to be signed if the agreement is enforceable under applicable law without signature.[75]

The IRS has indicated that a Plan sponsor should maintain the loan application, executed promissory note, proof that loan proceeds were used to purchase or construct a primary residence (if applicable), proof of loan repayments, in the event of default, proof of collection activities, and if there is a deemed distribution on Form 1099-R.[76]

Consequences of Violating Code § 72(p)

Violation in Form or in Operation.  A deemed distribution will occur when the requirements of Code § 72(p) are not satisfied in form or in operation.[77]

Deemed Distribution at Time Loan Is Made.[78]  If the terms of the loan do not require repayment within five years and level amortization or are not evidenced by an enforceable agreement in accordance with § 72(p) and the regulations, the entire amount of the loan is deemed distributed at the time the loan is made.  If the terms of the loan merely fail to satisfy the amount requirement of § 72(p)(2)(A), only the amount in excess of the permissible loan amount is a deemed distribution at the time the loan is made.

Later Deemed Distribution for Not Making Level Installment Payments.  If the loan initially satisfies the requirements of Code § 72(p), but repayments are not being made in accordance with the level amortization requirement of Code § 72(p)(2)(C), a deemed distribution occurs at the time of such failure.[79]  However, the plan administrator may allow a cure period extending up to the end of the calendar quarter following the calendar quarter in which the required installment payment was due and not made.  Such cure period given by the plan administrator will avoid a deemed taxable distribution until the end of the grace period.[80]  If the installment payment is not made before the expiration of the cure period, the entire outstanding balance of the loan (including accrued interest) will be a deemed distribution.[81] Chief Counsel Advice 201736022 provides two examples of failures to make loan payments under a qualified plan that were timely corrected, so that a loan default was avoided, and the loan was deemed to be satisfactorily reinstated.[82]  

Case-Law Regarding Deemed Distributions for Not Making Timely Payments.  There are various cases regarding deemed distribution under Code § 72(p) with income tax and Code § 72(t) early distribution tax for failure to make timely payments on participant loans. [83]  Several cases have held that failure to provide documentary evidence of the loan would result in a deemed distribution with ordinary income (and a 10% early distribution tax). [84]

Interest on Loan Not Included in Income.  Interest that accrues after a deemed distribution under Code § 72(p) is not included for purposes of Code § 72, and therefore the additional interest is not treated as an additional loan and does not result in an additional deemed distribution under Code § 72(p).[85]

Section 72(t) Tax.  When there is a deemed distribution of a plan loan, in addition to the income tax under § 72(p) there will also be a 10% Code § 72(t) early distribution tax if the deemed distribution occurs prior to age 59-1/2.[86]

Tax Reporting.  Any deemed distribution under Code § 72(p) must be reported on IRS Form 1099-R.[87]

Distinction between Taxable Deemed Distribution and Foreclosure

A Taxable Deemed Distribution Is Not Necessarily an Actual Distribution.  Even if Code § 72(p) is violated and there is a deemed taxable distribution under Code § 72(p), such distribution is not treated as an actual distribution for purposes of the in-service distribution restrictions under  § 401 regulations for money purchase plans, the eligible rollover distribution rules of Code § 402, the in-service distribution restrictions of Code § 401(k)(2)(B), or the vesting requirements of Treas. Reg. § 1.411(a)-7(d)(5) (regarding graded vesting schedule where prior distribution occurred).[88]  Thus, it is possible to be taxed on the deemed distribution at an earlier time than the actual distribution. A deemed distribution will therefore not be considered an in-service distribution or an eligible rollover distribution.  After a taxable deemed distribution occurs, the participant may still want to repay the loan, in order, for example, to be able to take a new plan loan.

A Plan Loan Offset (But Not a Default Alone) Is Treated as an Actual Distribution.  The regulations provide that an actual distribution occurs when, under the terms governing the plan loan, the accrued benefit of the participant is reduced (offset) in order to repay the loan.[89]  This might occur, for example, where the terms governing the plan loan require that if a participant requests a distribution, a loan must be repaid immediately or treated as in default.  A distributable event under the plan, e.g., age 59-1/2 or severance from employment, may be required to offset the loan.  The amount of the account balance that is used to offset the loan is treated as an actual distribution.  On the other hand, an event of default under the loan documents without an actual offset does not automatically cause there to be a Code § 72(p) taxable event.

Plan loan procedures may provide for offset for failure to make payments when due if a distribution is permitted.  Other common offset triggers are termination of employment or termination of the plan.[90]

Foreclosure Should Be Avoided if Restrictions on In-Service Distributions Apply.  Restrictions on in-service distributions (e.g., under Code § 401(k)(2)(B)) are violated if foreclosure occurs and the participant's accrued benefit is offset by the loan amount.[91]  (The same should apply with respect to the Code § 72(t) 10% penalty tax on early distributions.)  A taxable distribution under § 72(p) by itself, however, is not considered an in-service distribution, as stated above.

Coordination of Foreclosure with Requirement of Participant Consent to Actual Distributions.  Plan distributions in excess of $5,000 require a participant's consent under Code § 411(a)(11).  Thus, plan loan documents should provide that the participant consents both to the taking of the loan and to a foreclosure in the event of a default.

Coordination with Spousal Consent Requirements.  To foreclose on a plan loan, spousal consent, if applicable, is required.  Code § 417(a)(4) requires that no part of a participant's accrued benefit may be used as security for a loan from a plan subject to the qualified joint and survivor annuity rules and the qualified pre-retirement survivor annuity rules of Code § 401(a)(11) unless there is spousal consent.  Accordingly, spousal consent should be obtained at the time the loan is made.  See above, Pt. I, discussion of adequate security and spousal consent.

Foreclosure as Eligible Rollover Distribution; 20% Withholding Obligation.  A distribution from a qualified plan is subject to 20% mandatory withholding if the distribution is an "eligible rollover distribution" and the participant fails to elect a direct rollover.  As stated above, if a loan becomes a deemed taxable distribution because it does not comply with Code § 72(p), it is not an eligible rollover distribution and cannot be rolled over.[92]  The pre-1993 10% voluntary withholding rules apply in such case.[93]

If a loan is foreclosed by offsetting the accrued benefit, however, there is an actual distribution, and if this offset occurs prior to a deemed distribution this offset is considered an eligible rollover distribution which may be rolled over and is subject to 20% withholding.[94]  Although the foreclosed amount constitutes an eligible rollover distribution and is included in the amount subject to withholding, withholding need only be made from cash or other property distributed, and if there is no other cash or property distributed, there is nothing to withhold from.[95] 

If a deemed distribution of a loan or a loan offset results in income at a date after the loan is made, withholding is required only if a transfer of cash or property is made to the participant or beneficiary from the plan at the same time.[96]

Direct Rollovers and Trust-to-Trust Transfers of Notes.  A trust-to-trust transfer of assets (under Code § 414(l)) from one plan to another can include the transfer of a participant note.[97]  Ordinary rollovers, where amounts are first distributed to participants and then rolled over, should intuitively not be able to be made with a note because the interest of the lender and the borrower will merge once the note is distributed to the participant.  Nevertheless, recent regulations and rulings provide that a direct rollover under Code § 401(a)(31) may be made with a note even though a direct rollover is considered a distribution.[98]

Extension of Rollover Period for Offset Loans under Tax Cuts and Jobs Act of 2017.  If an offset of a loan occurs before the amount has been taxed as a deemed distribution (e.g., on account of termination of employment or termination of the plan), the offset loan is eligible for a tax-free rollover to an eligible retirement plan (including a qualified plan or an IRA) under Code § 402(c)(3)(A).[99]  Prior to the Tax Cuts and Jobs Act of 2017, the offset loan rollover would have to be made within 60 days from the date of offset.  The Tax Cuts and Jobs Act added Code § 402(c)(3)(C) to provide that, for plan loan offsets in tax years beginning after Dec. 31, 2017, the period during which a "qualified plan loan offset amount" (i.e., an offset due to termination of employment that results in failure to meet repayment terms of loan, or an offset due to termination of the plan) may be rolled over to an eligible retirement plan is extended from the 60 day period after the offset to the due date (including extensions) for filing an income tax return for the tax year in which the plan loan offset occurs.[100] Note that a rollover of an offset loan cannot be made where there was already a deemed distribution, since the tax was already paid.

Exemption from Truth-in-Lending Requirements

Plan loans used to be subject to federal truth-in-lending disclosure statement requirements under Regulation Z of the Truth-in-Lending Act.  However, effective July 1, 2010 Regulation Z was amended to specifically exempt 401(a), 403(b) and 457(b) participant loans from the truth-in-lending disclosure requirement, provided that the loan is comprised of fully vested funds from the participant's account and the loan is in compliance with the requirements of the Internal Revenue Code.[101]

Applicability of Loan Provisions to Individual Retirement Accounts (IRAs)

Loans from IRAs are not permitted.  Although IRAs are not subject to ERISA, they are subject to the Code § 4975 excise tax on prohibited transactions.[102]  Furthermore, pursuant to Code § 408(e)(2), if in any year an individual for whose benefit an IRA is established engages in any transaction prohibited by Code § 4975 with respect to the IRA, the IRA ceases to be an IRA as of the first day of such year (and all of the assets of the IRA on the first day of such year are treated as having been distributed on such day).[103]

Loans in Bankruptcy

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") provides that all retirement funds exempt from taxation under Internal Revenue Code §§ 401, 403, 408, 408A, 457 or 501(a) are protected from bankruptcy creditors.  Bankruptcy Code §§ 522(b)(3)(C) & 522(d)(12).  (IRAs are limited to $1 million as adjusted.  Bankruptcy Code § 522(n).)  With regard to participant loans, BAPCPA provides in Bankruptcy Code § 362(b)(19) that the bankruptcy petition does not operate as a stay for the withholding of wages to pay for participant loans under ERISA § 408(b)(1) or Code § 72(p).  Thus, withholding from wages for participant loans could remain in effect even though the participant is in bankruptcy.

With regard to Chapter 7 liquidations, BAPCPA introduced a means test (measuring monthly disposable income), and there are some cases regarding whether amounts withheld to repay participant loans are counted as part of the means test.[104]  This issue would not be applicable to a Chapter 13 individual bankruptcy filing, as the means test does not apply to Chapter 13 filings (and in fact was instituted to limit Chapter 7 filings to encourage Chapter 13 filings instead).

Impact of Loan Repayments on Code § 415 Annual Additions

Loan repayments are not treated as annual additions for purposes of Code § 415.[105]

Code § 411(d)(6)-Anti-Cutback Protection Not Applicable

Plan loans are not Code § 411(d)(6) protected optional forms of benefit and may be cut back or taken away without violating the anti-cutback rules.[106]

EPCRS Correction for Plan Loan Defaults

The Employee Plans Compliance Resolution System ("EPCRS") program in Revenue Procedure 2016-51 provides that where there is a failure to repay a plan loan by the end of the calendar quarter following the quarter in which the payments are due, which generally would be a taxable deemed distribution under § 72(p), the voluntary correction program ("VCP") of EPCRS can be used by reamortizing the loan balance over the remainder of the loan period or by repaying the arrears in lump sum, or a combination of the two.[107]  This may cure not just the operational failure but can also avoid the deemed distribution under § 72(p) (and a Form 1099-R reporting the deemed distribution will not be required), provided relief is specifically requested from the IRS that the loan failure will not result in § 72(p) deemed distribution tax.[108]  Alternatively, the VCP relief can be limited to reporting the deemed distribution in the year of correction instead of the year of failure.[109]  Examples when the IRS may limit the VCP relief to reporting the deemed distribution in the year of correction instead of the year of failure (and not avoiding the deemed distribution tax entirely) could be, for example, where the affected employee is a key employee or an owner-employee[110] or where the loan cannot be reamortized within the five year term and will need to be defaulted in the correction year. [111]

Prior to 2018, there were reduced VCP correction fees for loan failures based on the number of participants: (i) $300 for 13 or fewer affected participants; (ii) $600 for 50 or fewer affected participants; (iii) $1,000 for 100 or fewer affected participants; (iv) $2,000 for 150 or fewer affected participants; and (v) $3,000 for greater than 150 affected participants.[112] However, Rev. Proc. 2018-4 eliminates the reduced VCP fees for loan errors and provides for uniform VCP user fees (for all failures) based on the entire plan's assets as follows: (i) $1,500 if the plan's assets are of $500,000 or less; (ii) $3,000 if the plan's assets are $500,001 to $10,000,000; and (iii) $3,500 if the plan's assets are of over $10,000,000.[113]

Charles C. Shulman

[1]      In general, ERISA § 408(b)(1) and Code § 4975(d)(1) mirror each other.  There are some differences, however.  For example, ERISA applies even to nonqualified plans.  In addition, any employee of a plan sponsor is a party in interest under ERISA § 3(14); only a highly compensated employee is a disqualified person under Code § 4975(e)(2).  Therefore, prohibited transaction excise taxes under § 4975 would only apply to prohibited loans to employees who are highly compensated or are otherwise disqualified persons.
        The Department of Labor (DOL) regulations cited below apply equally to the ERISA requirements and the Code requirements pursuant to § 102 of Reorgani­zation Plan No. 4 of 1978, which  transferred the authority relating to these provisions from the Treasury Department to the Labor Department.  See, DOL Reg. § 2550.408b‑1(a)(1).
[2]      ERISA § 408(b)(1) and Code § 4975(d)(1); DOL Reg. § 2550.408b-1.
        DOL regula­tions provide that loans that meet the conditions of ERISA § 408(b)(1) are exempt not only from the prohibited transaction rules of ERISA § 406(a) (for extensions of credit to a party in interest) but also from the self-dealing prohibitions of ERISA § 406(b)(1) and (2).  DOL Reg. § 2550.408b-1(a)(1).  Such loans, however, are not exempt from the anti-kickback rule of ERISA § 406(b)(3) or the fiduciary duties of ERISA § 404.  DOL Reg. § 2550.408b-1(a)(2).   As stated above, the conditions of the above exemption must also be met so that the loan does not violate the anti-alienation rules of ERISA § 206(d)(2) and Code § 401(a)(13)(A).
[3]      DOL Reg. § 2550.408b-1(a)(3).
[4]      ERISA § 408(b)(1)(A).
[5]      DOL Reg. § 2550.408b-1(b)(1).
[6]      ERISA Advisory Opinion 89-30A; Preamble to DOL Regulations, 54 Fed. Reg. 30522 (July 20, 1989).
[7]      Note that a loan cannot be made available to certain owner-employees or certain shareholder-employees because the exemptions of ERISA § 408(b) do not apply to these individuals.  ERISA § 408(d).  (See, DOL Info. Ltr. to Thomas M. Curtin (Oct. 7, 1999) regarding a loan to a participant who later becomes an owner employee, quoted in 26 BNA Pen. & Ben. Rptr. 2437 (October 18, 1999).)
[8]      Treas. Reg. § 1.401(a)(4)‑10(c).
[9]      DOL Reg. § 2550.408b-1(b)(2).
[10]    DOL Reg. § 2550.408b-1(a)(4), Ex. 8.
[11]    DOL Adv. Op. 95-19A.
[12]    DOL Field Assistance Bulletin 2003-1 (April 15, 2003).
[13]    54 Fed. Reg. 30520, 30522 (July 20, 1989).  See DOL Field Assistance Bulletin 2003-3 that based on DOL Reg. § 2550-404c-1(b)(2)(ii)(A), reasonable expenses associated with taking a plan loan may be charged to the participant's account.
[14]    For 2018, highly compensated employees are:  those earning over $120,000 in 2017 (who, if the top-paid group election is made, are also in the top 20% group), or 5% owners.  Code § 414(q).
[15]    ERISA § 408(b)(1)(B).
[16]    DOL Reg. § 2550.408b-1(c).
[17]    ERISA § 408(b)(1)(C).
[18]    DOL Reg. § 2550.408b-1(d)(1).
[19]    DOL Reg. § 2550.408b-1(d)(2).
[20]    DOL Reg. § 2550.408b-1(d), Ex. (1).
[21]    54 Fed. Reg. 30520, 30523 (July 20, 1989).
[22]    ERISA § 408(b)(1)(D).
[23]    DOL Reg. § 2550.408b-1(e).
[24]    In practice, plan-wide rates are typically used, possibly in recognition of the fact that the 50% account balance collateral makes participants' other creditworthiness less meaningful.
[25]    DOL Reg. § 2550.408b-1(e), Ex. (1).
[26]    DOL Reg. § 2550.408b-1(e), Ex. (3).  See, preamble to final DOL regulations.  54 Fed. Reg. 30520, 30525 (July 20, 1989).  See, also, McLaughlin v. Rowley, 698 F. Supp. 1333 (N.D. Tex. 1988), which held that state usury laws with respect to plan loans are preempted by ERISA.
[27]    See McLaughlin v. Rowley, 698 F. Supp. 1333 (N.D. Tex. 1988) (where trustees of a defined contribution plan were held liable, among other things, for charging less than a prudent interest rate on plan loans to participants; the plan was an individual account defined contribution plan, although assets were pooled for investment purposes; the plan charged only 7% during the period 1977 to 1982; the DOL's expert witness testified that loans in such case are comparable to "compensating balance loans," which are loans that are secured by a sum of money deposited with the lender; the expert further testified that prudent lenders would charge fair market rates of interest at one or two percentage points above the rate paid on the a borrower's certificate of deposit; the rate would also vary in accordance with the size and the term of the deposit; the fact that the security for the loan is substantially the same as the amount of the loan does not matter; the court rejected the claim that the participants were merely borrowing their own money).
[28]    Participant Loans IRS Phone Forum, Sept. 12, 2011,; 38 BNA Pension & Benefits Reporter 1694 (Sept. 20, 2011).
[29]    DOL Reg. § 2550.408b-1(e), Ex. (2).
[30]    ERISA § 408(b)(1)(E).
[31]    DOL Reg. § 2550.408b-1(f)(1).
[32]    DOL Reg. § 2550.408b-1(f)(2).  See Part II below regarding 50% loan limit under Code § 72(p)(2)(A). 
        Note that while the 50% § 72(p) limit is a requirement at the time the loan is taken, it is not clear if the 50% adequate security requirement of DOL Reg. § 2550.408b-1(f)(2) must be met over the term of the loan.
[33]    Code § 401(a)(11).  Profit-sharing plans are not subject to spousal consent rules if the participant's entire accrued benefit is payable on death to his or her surviving spouse (or another designated beneficiary with the spouse's consent) and a life annuity payment form is not elected.  Code § 401(a)(11)(B)(iii).
[34]    Treas. Reg. § 1.401(a)-20, Q&A 24. 
[35]    The preamble to Treas. Reg. § 1.401(a)-20, 53 Fed. Reg. 31837, 31840 (August 22, 1988), states that the DOL has indicated that a loan may not be adequately secured if consent to a reduction in the accrued benefit is not obtained before the loan is secured.  Mardy, Loesel & Hamburger, Guide to Assigning & Loaning Plan Money ¶ 416 (Thompson Publishing Group), provides that the DOL concern is lessened by the "no loss" rule of the 1989 DOL regulations under which a delayed foreclosure is permissible as long as there are precautions taken to avoid loss of principal or interest on the loan.  It would seem, however, that since the inability to foreclose without spousal consent could result in loss of principal or interest on the loan, plans subject to the spousal consent requirement should require such consent at the time of the loan.
[36]    See, PLR 8933018 (interest on loans made to non-key employees that are secured by recorded deed on residence and not by amount attributable to § 401(k) deferrals is deductible).
[37]    See, Conference Report to TEFRA, H.R. Conf. Rep. No. 97-760 (1982), which states that residential mortgage investments made in the ordinary course of an investment program are not considered plan loans under § 72(p) if the loans do not exceed the fair market value of the property, are not self-directed investments of an individual account and are not made to officers, directors or owners.  The fiduciary duty and prohibited transaction rules must still be complied with.  Id.  See, also, Treas. Reg. § 1.72(p)-1, Q&A 18 which states that a mortgage investment program exists only if the plan has established, in advance of a specific investment, that a certain percentage or amount of the assets will be invested in residential mortgages.  The above regulations also impose certain additional requirements.  See, also, PLR 8824045 (mortgage loans made available only to plan participants are subject to § 72(p)); PLR 9110039 (mortgage loan program primarily for plan participants is subject to § 72(p)); DOL Adv. Op. 81-12A (mortgage loan program as a plan investment must be prudent).
[38]    When plans take the loan proceeds directly from a participant's accounts, this is often done in a certain order; for example, the following order: 401(k) contributions, catch-up contributions, rollover contributions, matching contributions, employer contributions, Roth contributions, Roth catch-up contributions, Roth rollovers, after-tax contributions.
[39]    See, DOL Reg. § 2550.408b‑1(f)(1) and Preamble to final DOL regulations, 54 Fed. Reg. 30520, 30526 (July 20, 1989).
[40]    Id.
[41]    DOL Reg. § 2550.408b-1(a)(3).
[42]    Id.
        See also, Treas. Reg. § 1.72(p)-1, Q&A 17 that if the loan is not bona fide (e.g., an understanding that the loan will not be repaid) the amount transferred is treated as an actual distribution and not as a loan or deemed distribution under Code § 72(p).
        In determining whether there is a bona fide loan, courts will focus on:  existence of a debt instrument, security, interest and fixed repayment date, record of loan, ability to repay, relationship of parties, and other factors.  See, e.g., Patrick v. C.I.R., T.C. Memo 1998-30 (transfers from profit sharing plan to two participants who were shareholders of the employer were taxable income to the participants and not plan loans). See also, Fuller v. C.I.R., T.C. Memo. 1980-370, 1980 WL 4206 (1980) (as long as the proper formalities are observed, the burden is on the IRS to prove that the transaction was not a loan; the court held that even though the employer, sole shareholder and loan recipient was also one of the plan's trustees, and even though loan repayments had been sporadic, a loan transaction in which the proper formalities had been observed was a loan, rather than a taxable distribution, from the plan).​
[43]    Id. 

[44]    A taxable distribution, in turn, may also trigger a 10% early distribution penalty tax under Code § 72(t), if applicable.  Treas. Reg. § 1.72(p)-1, Q&A 11, 65 Fed. Reg. 46591 (July 31, 2000).
[45]    Code § 72(p)(2); Treas. Reg. § 1.72(p)-1, Q&A 3.
[46]   Code § 72(p)(4); Treas. Reg. § 1.72(p)-1, Q&A 2.
[47]    All plans of an employer (determined under the rules of subsections (b), (c) and (m) of Code § 414) are treated as a single plan for purposes of the loan rules.  Code § 72(p)(2)(D)(i) and (ii).
[48]   The reason for adjusting the maximum by the repayment amount is to prevent an employee from effectively maintaining a permanent outstanding $50,000 loan balance. 21 H.R. Rep. 99-426 at 735 (1985).
       With respect to the maximum participant loan amount when the participant has prior loans, the IRS in Memorandum for Employee Plans (EP) Examinations Employees, revised at TE/GE-04-0417-0020 (July 26, 2017) (to be incorporated into IRM, provides that the IRS will permit two alternative methods for computing the highest outstanding balance within one year of the request for a new loan. As stated in the Memorandum for EP Employees, if a participant borrowed $30,000 in February which was fully repaid in April, and $20,000 in May which was fully repaid in July, before applying for a third loan in December, the plan may determine that no further loan would be available, since $30,000 + $20,000 = $50,000.  Alternatively, the plan may identify "the highest outstanding balance" as $30,000, and permit the third loan in the amount of $20,000.   Both methods will be acceptable on audit.
[49]    Code § 72(p)(2)(A).  Note that the 50% limit appears to be a requirement at the time the loan is made but not an ongoing obligation.  See Treas. Reg. § 1.72(p)-1, Q&A 4.
[50]    DOL Reg. § 2550.408b-1(f)(2).
[51]   This could be the sum of the highest outstanding balances for each loan during the one year period or alternatively the highest outstanding balance of all loans combined at any point during the one year period.  See discussion above regarding Memorandum for EP Employees (July 26, 2017).
[52]    Treas. Reg. § 1.72(p)-1, Q&A 19(b)(1).

See, Raymond H. v. C.I.R., T.C. Memo. 2011-139, aff'd, 2012-1 U.S. Tax Cas. (CCH) P 50391, 2012 WL 2036776 (5th Cir. 2012) (an individual who was a long time U.S. Air Force employee had borrowed money from his thrift savings plan; repayments were to be made by payroll withholding; the individual lost his job and the plan notified the individual that the remaining portion of the loan was due; he did not timely repay the loan and received a Form 1099R for a deemed distribution; the individual filed with the Tax Court, which held that he received a constructive distribution and was subject to the additional 10% tax under IRC § 72(t) for a premature distribution); Marquez v. C.I.R., T.C. Summ. Op. 2009-80, 2009 WL 1405883 (T.C. 2009) (the refinancing of a plan loan under which both the original and new loan were treated as being outstanding for purposes of IRC § 72(p)(2), resulted in a constructive distribution and the imposition of a 10% premature distribution tax; when the refinancing was authorized, the participant was advised that an additional loan could be made on the same terms as the original loan, or a new loan for a smaller amount could be made, either of which alternatives would have avoided exceeding the permissible loan limitation); Billups v. I.R.S., T.C. Summ. Op. 2009-86, 2009 WL 1519901 (T.C. 2009) (a participant refinanced a loan from a qualified plan, which resulted in exceeding the permissible loan limitation under IRC § 72(p); the individual had an outstanding loan balance of $27,013, and the participant refinanced it to borrow an additional $12,630, thus increasing his loan balance to $39,748; Tax Court determined that his loan would violate IRC § 72(p) limitations if it exceeded one-half of his $52,863 loan balance; court concluded that the sum of the new loan and the loan it replaced was $66,655 ($39,642 + $27,017), and that amount exceeded the applicable 50% of his account balance (the highest amount of permissible loan value without exceeding IRC § 72(p) limitation) by $39,748).​

[53]    Treas. Reg. § 1.72(p)-1, Q&A 19(b)(2).  67 Fed. Reg. 71821 (December 3, 2002).
[54]    See discussion below in section entitled "Proposed Amendments Regarding Refinancing and Multiple Loans" regarding a controversial proposed regulatory limit of two loans per year. 
[55]    Code § 72(p)(2)(B).
[56]    Conference Report to TEFRA 1982; Treas. Reg. § 1.72(p)-1, Q&A 4.
[57]    Joint Committee of Taxation General Explanation to TEFRA 1982 (Blue Book) § IV.D.2.
[58]    Code § 72(p)(2)(B)(ii).
[59]    See, Mardy, Loesel & Hamburger, "Guide to Assigning & Loaning Plan Money," ¶ 465.  See also, Treas. Reg. § 1.72(p)-1 (“The examples included . . . are based on the assumption that a bona fide loan is made to a participant . . . with adequate security and with an interest rate and repayment terms that are commercially reasonable”).
[60]    Treas. Reg. § 1.72(p)-1, Q&A 5.
[61]    Treas. Reg. § 1.72(p)-1, Q&A 6.
[62]    Treas. Reg. § 1.72(p)-1, Q&A 7.
[63]    Treas. Reg. § 1.72(p)-1, Q&A 8.  See Part I above regarding mortgage loans and mortgage investment programs.
[64]    Code § 72(p)(2)(C). 
[65]    DOL Adv. Op. 94-27A.  It held that Dreyfus Service Corporation's telephone voice response system could be used to make salary deferrals into pension plans because New York Labor Law § 193, which requires written authorization for payroll deductions (implying that telephone requests are not sufficient), is preempted by ERISA with respect to employee benefit plans.
        The New York State Department of Labor has issued at least one opinion that written authorization for payroll deductions may be satisfied when a blanket authorization has been made in writing for any future loan requests by electronic communications.  Butterworth, "Paperless Plan Administration:  Electronic Communications from Employees," 22 Tax Mgmt. Comp. Plan. J. 8 (August 5, 1994).
[66]    DOL Adv. Op. 96-01A.  It involved § 5(g) of Puerto Rico Act No. 17, which allows payroll deductions in writing for purposes of mandatory contributions to pension and savings plan, implying their payroll deductions for purposes of repaying plan loans would not be permitted.  The DOL held that § 5(g) is preempted by ERISA and ERISA § 514, since particularly, § 5(g) attempts to specifically regulate ERISA-covered plans.
[67]    Treas. Reg. § 1.72(p)-1, Q&A 9(a).
[68]    Treas. Reg. § 1.72(p)-1, Q&A 9(a) & Q&A 9(d) Ex. (1).
See, however, Frias v. C.I.R., T.C. Memo 2017-139 (a plan loan taken before a leave of absence was considered a plan distribution since the participant failed to begin making payments even though she was received paychecks from her employer while on leave).
[69]   Treas. Reg. § 1.72(p)-1, Q&A 9(b) & (c); Conf. Rep. to TRA 1986.
The participant loan interest rate may be restricted during the military service to 6% under the Soldiers & Sailors Civil Relief Act Amendments of 1942.  See, Treas. Reg. § 1.72(p)-1, Q&A 9(d), Ex (2).
[70]    Treas. Reg. § 1.72(p)-1, Q&A 20(a)(1).  67 Fed. Reg. 71821 (Dec. 3, 2002).
[71]    Treas. Reg. § 1.72(p)-1, Q&A 20(a)(2).
[72]    Treas. Reg. § 1.72(p)-1, Q&A 3(b).
[73]    Treas. Reg. § 1.72(p)-1, Q&A 3(b)(2).
[74]    Id.
[75]    Treas. Reg. § 1.72(p)-1, Q&A 3(b).  In 65 Fed. Reg. 46677 (July 31, 2000) the Treasury asked for comments on the impact of the Electronic Signatures in Global and National Commerce Act, P.L. 106-229, June 30, 2000, 15 U.S.C. §§ 7001-7031, on plan loan transactions.
[76]   Employee Plans News (April 1, 2015).  See also Fidelity Points of View (April 2015) criticizing the requirement to have documentation verifying that the loan proceeds were used to purchase or construct the home.
[77]    Treas. Reg. § 1.72(p)-1, Q&A 4(a).
[78]    Id.
[79]    Treas. Reg. § 1.72(p)-1, Q&A 4(a) & 10(a).  The same is true for the other requirements of § 72(p) such as the five-year repayment requirement.  Treas. Reg. § 1.72(p)-1, Q&A 4(a).
[80]    Treas. Reg. § 1.72(p)-1, Q&A 10(a). 
[81]    Treas. Reg. § 1.72(p)-1, Q&A 10(b).
[82]   In the first situation, loan payments were missed in two consecutive months, March 31 and April 30, which fell in different calendar quarters.  Loan payments were resumed in the following two months and applied to the previously missed payments.  In the third calendar quarter, the individual caught up all payments so that the loan was current.  In the second situation, the taxpayer missed payments for three consecutive months during the fourth quarter of the year.  In the following quarter, the taxpayer refinanced the loan with a new replacement loan equal to the outstanding balance of the original loan including the missed payments.  In both cases Chief Counsel Advice 201736022 held that the missed loan payments were timely corrected, so that a loan default was avoided.
[83]    See, e.g., Leon v. C.I.R., T.C. Summ. Op. 2008-86, 2008 WL 2796058 (T.C. 2008) (distribution following termination of employment includible in income under § 72(p) and subject to § 72(t) 10% penalty on early distribution on the expiration of the 90-day grace period to repay the loan); Plotkin v. C.I.R., T.C. Memo. 2001-71, T.C.M. (RIA) P 2001-071 (2001) (money purchase plan loan to sole shareholder violated the five year payment requirement and in addition to being a taxable distribution under § 72(p) would also be subject to the additional 10% early distribution tax under § 72(t)); Raymond H. v. C.I.R., T.C. Memo. 2011-139, T.C.M. (RIA) P 2011-139 (2011), aff'd, 2012-1 U.S. Tax Cas. (CCH) P 50391, 109 A.F.T.R.2d 2012-2433, 2012 WL 2036776 (5th Cir. 2012) (an individual who was a U.S. Air Force employee had borrowed money from his thrift savings plan; repayments were to be made by payroll withholding; the individual lost his job and the plan notified the individual that the remaining portion of the loan was due; he did not timely repay the loan and received a Form 1099-R for a deemed distribution; the individual filed with the Tax Court, which held that he received a constructive distribution and was subject to the additional 10% tax under IRC § 72(t) for a premature distribution); Matthews v. C.I.R., T.C. Summ. Op. 2014–84, 2014 WL 4251116 (T.C. 2014) (a participant who had a plan loan outstanding requested a distribution of funds from his 401(k) plan; he asked that the funds be used first to pay off the loan, a portion of the funds were withheld for income tax and the remaining were distributed to him and used for a rollover IRA; the Tax Court held that the 10% premature distribution penalty under IRC § 72(t) applied to the amount of the distribution used for the loan payoff); El v. C.I.R., Tax Ct. Rep. (CCH) 60251, Tax Ct. Rep. Dec. (RIA) 144.9, 2015 WL 1063061 (T.C. 2015) (Tax Court held that the 10% tax imposed under IRC § 72(p) for exceeding the permissible requirements for a loan under IRC § 72(p)(2) is not a penalty for purposes of IRC § 7491(c); therefore, the IRS does not bear the burden of proving that an assessment under § 72(p) is proper); Gowen v. C.I.R., TC Summary Opinion 2017-57 (Tax Court held that a CPA who defaulted on a plan loan during one tax year must include the deemed distribution once the cure period for repayment expires in the next tax year; the CPA who had a master's degree in taxation allowed a loan payment to a qualified plan to go into default in the third quarter of the year and failed to cure the default by the end of the fourth quarter; the CPA argued that the failure should be reported in the following tax year because he did not receive final notice from the plan custodian until after the end of the year; however, the Tax Court held that the failure was reportable for the year in which the failure occurred rather than the following year).
[84]    Olagunju v. C.I.R., T.C. Memo. 2012-119,  2012 WL 1392677 (holding that a distribution had to be included in gross income when the record contained no loan documents or other evidence showing that the distribution was evidenced by a legally enforceable agreement); Bormet v. C.I.R., T.C. Memo 2017-201 (an individual who obtained an initial loan, suffered an injury and received short-term and then long-term disability benefits, was reported by the retirement plan's TPA as being in default for nonpayment of a loan for $26,954; the individual claimed that the loan had been renegotiated but was unable or unwilling to offer any evidence that the loan was renegotiated or evidence of his disability; the Tax Court concluded that there was insufficient evidence of a renegotiated loan and determined that the entire unpaid balance of $26,954 should be includable in the individual's income)..
[85]    Treas. Reg. § 1.72(p)-1, Q&A 19(a).
[86]    Treas. Reg. § 1.72(p)-1, Q&A 11. See, e.g., Leon and Tilley v. C.I.R., 2008 WL 2796058, 44 E.B.C. 2405 (2008) (distribution following termination of employment includible in income under § 72(p) and subject to § 72(t) 10% penalty on early distribution on the expiration of the 90 day grace period to repay the loan); Plotkin v. C.I.R., T.C. Memo 2001-71 (2001) (money purchase plan loan to sole shareholder violated the five year payment requirement and in addition to being a taxable distribution under § 72(p) would also be subject to the additional 10% early distribution tax under § 72(t)).
[87]    Treas. Reg. § 1.72(p)-1, Q&A 14.
[88]    Treas. Reg. § 1.72(p)-1, Q&A 12.  See also, Treas. Reg. § 1.402(c)-2, Q&A 4(d), Treas. Reg. § 1.401(k)-1(d)(6)(ii), and Notice 93-3, 1993-1 C.B. 293.
[89]    Treas. Reg. § 1.72(p)-1, Q&A 13; Treas. Reg. § 1.402(c)-2, Q&A 9(a).
[90]    Plan loan procedures typically provide for various events of default.  The most basic one is failure to make payments when due.  Some administrators treat loans as being in default if payments are not made for three months, since that is the period after which they will be considered to be taxable distributions.  Another common event of default is termination of employment.  Termination of the plan will often cause an event of default.  Once an event of default has occurred the admini­strator may foreclose (unless otherwise prohibited from doing so) by offsetting the account balance.  A foreclosure is generally treated as a distribution.  Foreclosure occurs when the participant's account balance is offset by the loan amount.
[91]    Treas. Reg. § 1.72(p)-1, Q&A 13(b).
[92]    Treas. Reg. § 1.402(c)-2 Q&A 4(d); Treas. Reg. § 1.72(p)-1, Q&A 12; Notice 93-3, 1993-1 C.B. 293. 
[93]    Treas. Reg. § 35.3405‑1T, Q&A F‑4 & F-5.              
[94]    Treas. Reg. § 1.402(c)‑2, Q&A 9; Notice 93‑3, 1993-1 C.B. 293.
[95]    IRS Notice 93‑3 § III(b)(3), 1993-1 C.B. 293.
[96]    Treas. Reg. § 1.72(p)-1, Q&A 15.  To the extent that a loan constitutes a deemed distribution that results in income at the time the loan is made, withholding is required for such deemed distribution regardless of whether there is other cash or other property to withhold from.  Id.
[97]    PLR 8910034; PLR 8950008.
[98]    Treas. Reg. § 1.401(a)(31)-1, Q&A 16 ("A plan administrator is permitted to allow a direct rollover of a participant note of a plan loan to a qualified trust"). See also, PLR 9617046 (Jan. 31, 1996) (newly-transferred employees rolled over loan notes from one plan to another plan, with the transferee plan requiring the participant to acknowledge that transferee plan is new obligee; IRS held that the transfer of a loan note as a direct rollover under § 401(a)(31) could be made and would not be a taxable distribution under Code § 402(a) or 72(p); also since substantive terms of loan have not changed, not considered a revision or renegotiation of the loan and therefore not a new loan under § 72(p); PLR 9729042 (direct rollover of note is permissible, and will not be a taxable distribution).  See, also, Treas. Reg. § 1.402(c)-2, Q&A 9; 23 BNA Tax Mgmt. Compensation Plan. J. 195 (Aug. 4, 1995); 18 BNA Pen. Rptr. 2118 (Nov. 30, 1992); 92 TNT 235-3 (Nov. 24, 1992).  It is not clear from the regulations if a direct rollover of a note would be considered like a new loan from the transferee plan.
[99]   A deemed distribution is not eligible to be rolled over to an eligible retirement plan since it is not considered a distribution.  Treas. Reg. § 1.72(p)-1, Q&A 12.
[100]   Code § 402(c)(3)(C) as added by the Tax Cuts and Jobs Act of 2017 § 13613.
[101]  12 CFR § 226.3(g).
[102]  Although an IRA does not explicitly fit within the definition of disqualified person under Code § 4975(c)(2), the Conf. Rep. to ERISA, Rep. No. 43-1280 at 501, and PLR 8849001 support the view that transactions between the IRA and the IRA owner are prohibited transactions.
[103]  Code § 408(e)(2)(A) and (B).  See, also, Code § 408(e)(4).
[104]  See, e.g., In re Egebjerg, 574 F. 3d 1045 (9th Cir. 2009) (holding that a 401(k) loan is not a debt since the participant is merely paying it to himself, and Egebjerg could not include his payments on the participant loans as deductions for calculating monthly disposable income for the means test).  See also, Welmerink, "Cleaning the Mess of the Means Test: The Need for a Case-by-Case analysis of 401(k) Loans in Chapter 7 Bankruptcy Petitions," 41 Golden Gate U.L. Rev. 121 (Fall 2010). 
[105]  Treas. Reg. § 1.415-6(b)(3)(ii).
[106]  Treas. Reg. § 1.411(d)-4, Q&A 1(d)(4).
[107]   Rev. Proc. 2016-51, §§ 6.02(6) & 6.07.  This relief was originally provided in Rev. Proc. 2006-27, §§ 6.02(6) & 6.07.
[108]  Rev. Proc. 2016-51, § 6.07(2)(a) & (3).  See Rev. Proc. 2016-51, § 6.02(6) that for defaulted loans the employer should pay a portion of the correction payment equal to the interest that accumulates as a result of such failure (generally determined at a rate equal to the greater of the plan loan interest rate or the rate of return under the plan).
[109] Rev. Proc. 2016-51, § 6.07(1).
[110] Form 14568-E (Model VPC Compliance Statement for Plan Loan Failures), § IIA & B, provides that if the affected participant is either a key employee under Code § 416(i)(1) (e.g., an officer earning over $175,000 in 2018) or an owner-employee under Code § 401(c)(3), relief will be limited to reporting the deemed distribution in the year of correction instead of the year of failure.
[111] See also Rev. Proc. 2016-51, § 6.07(2)(a), that the IRS can deny correction to entirely avoid a deemed distribution if it deems appropriate, e.g., where the loan failure is not caused by employer action. 
[112]  Rev. Proc. 2015-27, at § 4.13 and Rev. Proc. 2017-4, App. A .08.
[113]  Rev. Proc. 2018-4, at § 2.03(4) (eliminating specific reduced VCP fees, beginning in 2018); Rev. Proc. 2018-4, at § 2.03(1) and App. A .09 (beginning in 2018, VCP user fees now based on plan assets).

Monday, December 4, 2017



Pension Plan and Related Limits
Pre-tax elective deferral maximum under IRC § 401(k), 403(b), and 457(b) plans
Age 50 and older “catch-up” adjustment for 401(k), 403(b), and governmental 457(b) plans and SEPs
Annual compensation limit under IRC §§ 401(a)(17), 404(l) and 408(k)
Annual benefit limit for defined benefit plans under IRC § 415(b)
Annual contribution limit for defined contribution plans under IRC § 415(c)
Highly compensated employee threshold for purposes of nondiscrimination testing in the following year under IRC § 414(q)(1)(B)
Key employee threshold for officers for top heavy plan under IRC § 416(i)(1)(A)(i)
IRC § 430(c)(7)(D)(i)(II) amount for determining excess employee compensation for single-employer defined benefit plans where election has been made
No longer applicable
ESOP account balance for five-year and one-year distribution rule under IRC § 409(o)(1)(C)(ii)
$1,105,000 and
Minimum earnings level to qualify for SEP under IRC § 408(k)
SIMPLE plan elective deferral limit under IRC § 408(p)(2)(E)
SIMPLE plan age 50 catch-up
Basic IRA/Roth IRA contribution limitation under IRC § 219(b)(5)(A)/§ 408A (age 50 $1,000 catch-up for IRAs does not have cost-of-living adjustment)
Phase-out for deductions for IRA for married couples filing jointly, in which the spouse who makes the IRA contribution is an active participant in an employer-sponsored retirement plan

$99,000 to $119,000
$101,000 to $121,000
Adjusted gross income (AGI) phase-out range for married joint filers making contributions to a Roth IRA –

For single filers –
$186,000 to $196,000

$62,000 to
$189,000 to $199,000

$63,000 to
AGI limit for retirement savings contributions (saver's) credit for married couples filing jointly –

For single filers –


Health Savings Account contribution limits (single and family)
$3,400 and $6,750
$3,450 and $6,900
PBGC guaranteed benefit (yearly)
PBGC flat-rate premiums per participant for a single-employer plans
PBGC variable-rate premium for single-employer plans per $1,000 of Unfunded Vested Benefits
PBGC (flat-rate) premiums for multiemployer plans per participant
Taxable wage base subject to FICA tax

Friday, October 14, 2016

Employment Agreements (Including Severance, Parachute, Clawback, Noncompete and §409A Issues)

See "Employment Agreements (Including Severance, Parachute, Clawback, Noncompete and §409A Issues)" by Charles C. Shulman, at Tax Management Compensation Planning Journal 9-2-2016
Employment agreements, which are very common for executives and senior management, raise a number of issues relating to terms of employment, severance on termination, change in control, excess parachute tax under Internal Revenue Code §280G, noncompete provisions, clawback provisions, SEC disclosure requirements, and restrictions on nonqualified deferred compensation under §409A.
The terms of employment agreements and severance arrangements are of particular relevance in corporate transactions. Executives may be terminated as a result of a transaction, and the general severance provisions in the employment agreements may be triggered.
Severance provisions are often triggered on termination of employment only if there is also a change in control of the employer, or the amount of severance may be more generous if the termination occurs after a change in control. Some agreements may allow an employee to quit for any reason and still receive severance, if the quitting is in connection with a change in control. Employment and change in control agreements often provide that options will vest on a change in control typically even without a termination of employment. 

Wednesday, May 4, 2016

Whether Private Equity Funds are a Trade or Business - Sun Capital Partners III v. N. E. Teamsters Truck. Industry Pension Fund

Whether Private Equity Funds are a Trade or Business -
Sun Capital Partners III v. N. E. Teamsters Truck. Industry Pension Fund

1.  Background on Controlled Group Liability

a. Controlled Group Liability.  Controlled group status as a single employer as set forth in IRC §414(b) and (c) apply for termination liability, multiemployer withdrawal liability, PBGC premiums, minimum funding obligations, COBRA continuation coverage, etc.

b. Parent-subsidiary test. A parent-subsidiary controlled group will exist if there is a chain of entities conducting trades or businesses that are connected through a controlling interest with a common parent, with controlling interest being defined: (i) in the case of corporation as at least 80% of the total combined voting power of all classes entitled to vote or at least 80% of the total value of all shares; (ii) in the case of a trust or estate an 80% actuarial interest; (iii) in the case of a partnership (or entity taxed as a partnership) an 80% interest in profits or capital; and (iv) in the case of a sole proprietorship 100% ownership. IRC §1563(a)(1); Treas. Reg. §1.414(c)-2(b)(2).

c. Brother-sister test. A brother-sister controlled group exists where there are two or more trades or businesses which meet two tests: (i) the same five or fewer persons who are individuals, estates or trusts own together 80% or more of “control” as defined above in each of the entities; and (ii) such five individuals own together 50% or more of the entities where ownership is taken into account only to the extent it is identical with respect to each such trade or business.  IRC §1563(a)(2); Treas. Reg. §1.414(c)-2(c). That is, if corporations X, Y and Z are partially owned by individual A with a 20%, 30% and 40% interest, respectively, the identical ownership interest that is counted for individual A is only 20%.

d. Trade or business.  A trade or business is generally interpreted to mean regular and continuous activities that are designed to produce income.  Neither ERISA nor the Treasury Regulations define “trade or business.” Courts have generally adopted the standard articulated in C.I.R. v. Groetzinger, 480 U.S. 23, 35, 107 S. Ct. 980, 987, 94 L. Ed. 2d 25 (1987), where the Supreme Court held that in the context of IRC §162: “to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose for engaging in the activity must be for income or profit. Sporadic activity, a hobby, or an amusement diversion does not qualify.”

e. Liability of sole proprietor engaging in trade or business. Although individual shareholders of corporations are not liable for the corporation's Title IV liabilities under the controlled group rules, a controlled group includes a trade or business, and thus any unincorporated trade or business that an individual operates, e.g., a sole proprietorship or a partnership, would indirectly cause him or her to be individually liable for the plan termination.  Many courts have found shareholders liable by reason of some activity they engaged in as a sole proprietor.

2.  Whether Private Equity Funds are a Trade or Business

a. Trade or Business. Only “trades or business” under common control are treated as part of an ERISA controlled group. Neither ERISA nor the Treasury regulations define “trade or business.” As stated above, courts have generally adopted the standard articulated in C.I.R. v. Groetzinger, where the Supreme Court held that a trade or business is an activity with continuity and regularity and for the primary purpose for income or profit (while sporadic activity, a hobby, or an amusement diversion does not qualify).

b. 2007 PBGC Appeals Board Opinion – Private Equity Investors are Not Passive Investors.  With regard to private equity funds many practitioners had taken the view that since they are generally passive investment vehicles with no employees and minimal involvement in day-to-day operations, they are not trades or businesses, and therefore separate portfolio companies owned by a private equity fund or funds would not be in the same ERISA controlled group. However, the PBGC ruled in a 2007 PBGC Appeals Board Opinion that a private equity fund was a trade or business, because it was engaged in an activity with the primary purpose of income or profit and conducted business through an agent (the general partner) who managed fund investments on a regular basis.

c. 80%-owned portfolio companies of a private equity fund. According to this PBGC ruling, 80%-owned portfolio companies of a private equity fund would generally be in the same ERISA controlled group (except in a rare case where the fund's activity does not meet the Groetzinger standard).

d. Palladium Equity Partners 2010 Case Affirming PBGC Opinion and Investment Plus.  A 2010 Eastern District of Michigan case found the 2007 PBGC Appeals Board Opinion to be persuasive and “investment plus” is a trade or business. Board of Trustees, Sheet Metal Workers National Pension Fund v. Palladium Equity Partners, 722 F. Supp. 2d 854 (E.D. Mich. 2010) (genuine issue of material fact existed as to whether three Palladium limited partnerships, as well as Palladium Equity Partners, LLC which served as advisor, were an ERISA controlled group parent liable for ERISA multiemployer withdrawal liability of the Haden group of companies; the court found the 2007 PBGC Appeals Board Opinion to be persuasive that although investment alone is not a trade or business, where there is “investment plus,” e.g., investment advisory and management services by the fund for the benefit of its partners and compensation for the investment advisory and management services, this  would constitute a trade or business; court found there was a genuine issue of material fact as to whether the Palladium funds had a business purpose other than merely investment; the Palladium funds joined their investments to exert power over financial and managerial activities of the portfolio companies, selected five of the seven board members and set up several committees to control the internal operations of the portfolio companies; there was also general issue of material fact regarding alter-ego liability).

e. Sun Capital Partners III, LP 2013 First Circuit Case.  A 2013 First Circuit case, Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, overturned a district court case and it also found the PBGC Appeals Board Opinion to be persuasive.  724 F.3d 129 (1st Cir. 2013), cert. denied, 134 S. Ct. 1492 (2014):
  • two private equity funds managed by Sun Capital owned 70% and 30% of Scott Brass, Inc. which withdrew from a multiemployer pension plan prior to filing for bankruptcy; Scott Brass was indirectly wholly owned by Sun Fund III (30%) and Sun Fund IV (70%);
  • the district court at 903 F.Supp.2d 107 (D. Mass. 2012), had granted the Sun Capital Partners equity funds’ motion to dismiss holding that the private equity funds were passive investors and not a trade or business and the 2007 PBGC Appeals Board Opinion was found by the district court to be unpersuasive because activity of the general partner should not have been attributed to the investment fund and continuity and regularity of an activity should not be found merely based on the size of the investment and profitability;
  • however, the First Circuit overturned the district court ruling regarding the funds being a “trade or business” and held that at least the larger of the two Sun funds (Fund IV) was engaged in a trade or business under aninvestment plusanalysis since there was more than mere passive investment, noting that

o   the funds sought out potential portfolio companies that were in need of extensive management intervention,
o   the general partners of the funds had wide range management authority,
o   the funds had the power to appoint a majority of board members,
o   the general partners of the funds could make decisions regarding hiring, termination and compensation of employees in the portfolio companies, and
o   at least with respect to Sun Fund IV (the 70% owners) the active investment in management provided a direct economic benefit that an ordinary passive investor would not derive, i.e., management fees the fund otherwise would have needed to pay its general partner of the fund was offset by fees the underlying company was paying to the general partner.
  • both the district court and the First Circuit found in regard to Sun Capital funds that the purchase of Scott Brass, Inc. in a 70%-30% split was not done with a principal purpose to evade or avoid liability under ERISA §4212(c), according to the district court because there were legitimate business reasons for the investment ownership in order to decrease investment risk for each fund and according to the First Circuit because disregarding a 70%-30% split would leave zero ownership;
  • the First Circuit remanded the case to the district court to determine if there was a trade or balance in Sun Fund III (the 30% owners) and to determine if there was common control by the 70%-30% ownership (for example if the joint venture is seen as common ownership). 

f. Sun Capital Partners III, LP, 2016 D.C. Mass. Decision on Remand.

On remand of Sun Capital Partners from the First Circuit, the District Court in Massachusetts ruled that: (i) both funds (the Sun Fund IV with a 70% investment and Sun Fund III with a 30% investment) were trades or businesses, and (ii) that there was common control under ERISA by reason of Fund III and IV being a "partnership in fact."  Sun Capital Partners III, LP v. New England Teamsters and Trading Industry Pension Fund, _ F. Supp. 3d _, 2016 WL 1239918 (D. Mass. March 28, 2016).

The District Court of Mass. in 2016 held that:

  • under the "investment plus" analysis not only was Sun Fund IV a trade or business, but Sun Fund III was also a trade or business because it too had a direct economic benefit that a passive investor would not have, i.e., an offset of fees otherwise owed by Sun Fund III to its general partner for managing the investments that were indirectly paid by the underlying portfolio company; and

  • with regard to controlled group common ownership, Sun Fund IV and Sun Fund III of Scott Brass, Inc. (with 70% and 30% ownership), while not specifically meeting the requirements for an ERISA controlled group because there was no 80% controlling interest, nevertheless Sun Fund III and Sun Fund IV are a jointly controlled entity where there was a partnership-in-fact since the two funds often co-invest together, and despite the lack of permanently fixed co-investing, these Sun Funds should be considered as joining together as a "partnership-in-fact" to invest in Scott Brass.

  • The district court noted that the fund split in ownership was done because the fund was nearing the end of its investment cycle, a preference for income diversification and a desire to keep ownership below 80% to avoid ERISA withdrawal liability (though avoiding controlled group liability was not the principal purpose of the transaction for purposes of ERISA § 4212(c)).
Sun Capital Partners appealed the District Court decision to the First Circuit on April 8, 2016.

g. Criticism of 2016 District Court Sun Capital Partners Case.  The latter holding of the Sun Capital district court case that there was an ERISA controlled group with regard to the funds because of a partnership-in-fact (resulting in aggregation of the ownership interests despite the lack of partnership formalities) is a puzzling holding for the following reasons:
  • partnership-in-fact is tax law concept that should not be automatically applied to ERISA controlled group liability situations;
  • finding an ERISA controlled group could have consequences beyond withdrawal liability, such as single employer plan termination liability, non-discrimination testing, being a single entity for COBRA and IRC § 409A purposes and defaults in credit agreements; and
  • the bright line ERISA controlled group test was being expanded in a way not contemplated by the statute or regulations.

Monday, May 4, 2015

Supreme Court Strikes Down Yard-Man Inference for Collectively Bargained Retiree Health Benefits to Continue for Life - M & G Polymers v. Tackett - 5/4/2015

M & G Polymers v. Tackett (Supreme Court Jan. 2015) Strikes Down
Yard-Man Inference for Collectively Bargained Retiree Health Benefits
to Continue for Life; Court Holds Ordinary Contract Provisions Apply

·         Since the early 1990s there has been a push by employers to cut back or terminate retiree health plans.

·         In contrast to pension (qualified plan) benefits, welfare benefits do not vest by operation of law, but an employer can contractually obligate to vest benefits.

·         There may be statements or communication implying lifetime benefits, but the plan documents and communication often reserve the right to modify or discontinue the benefits (so that there be no issue of a contractual lifetime obligation).

·         Where retiree health benefits were the subject of collectively bargained negotiations, the Sixth Court in International Union, United Auto, Aerospace and Agr. Implement Workers of Am. (UAW) v. Yard-Man, Inc., 716 F.2d 1476 (6th Cir. 1983), held that there is an inference that the intent was for these bargained-for benefits to continue throughout retirement even after the expiration of the term of the collective bargaining agreement.
·         The First and Eleventh Circuits have followed this Sixth Circuit view of the Yard-Man inference.  The Third, Fifth and Eighth Circuits have rejected it.  (The Seventh Circuit first adopted the Yard-Man view, but then rejected it.)

·         The Sixth Circuit itself also cut back on the Yard-Man inference, limiting it to retiree health, to actual retirees, to cases where union contract evidences an intent to vest benefit and to where retiree health was specifically bargained for.

·         In a January 2015 decision, M & G Polymers USA, LLC v. Tackett, 135 S.Ct. 926 (January 26, 2015), the Supreme Court reversed a Sixth Circuit 2013 decision which had ruled in favor of retirees with respect to lifetime retiree health benefits that were bargained for based on the Yard-Man inference that bargained-for benefits are presumed to continue through retirement.  The Supreme Court struck down the Yard-Man inference and held that collective bargaining agreements are subject to ordinary principles of contract law.  The collective bargaining agreement in M & G Polymers did not promise the retiree benefits for life, and in fact the agreement stated that the benefits would be provided for the duration of the agreement and would be subject to renegotiation in three years.  The Court stated that traditional contract rules would dictate that ambiguous writings in collective bargaining agreements do not created lifetime promises, and contractual obligations will cease in the ordinary course on termination of the bargaining agreement.  Therefore the Supreme Court vacated the Sixth Circuit ruling in this case, and this case was remanded to the lower court to make a finding without the Yard-Man inference.

·         Details of the Case: M & G Polymers USA, LLC v. Tackett, 135 S.Ct. 926 (Jan. 26, 2015) (predecessor employer, Point Pleasant Polyester Plant, had provided to union employees (who were eligible for a pension benefit) employer-paid retiree health benefits, and this was negotiated in the pension & insurance agreement attached to the collective-bargaining agreement; the agreement provided for the benefits to be provided for the duration of the labor agreement (three-year term until next negotiation); these provisions were also included in the collective bargaining agreement negotiated by M & G Polymer USA, LLC, which purchased the plant in 2000; in 2006 M & G Polymers announced that it would begin requiring retirees to contribute to the cost of the retiree health benefits; retirees sued arguing that they were promised lifetime employer-paid benefits; the Sixth Circuit in 2009, 561 F.3d 478, held that, based on the Yard-Man Sixth Circuit 1983 decision, there was an inference that bargained-for retiree benefits would vest for life, and the district court then found for the retirees; the Sixth Circuit affirmed this decision in 2013, 733 F.3d 586; the Supreme Court granted certiorari and reversed the decision; the Court noted that welfare benefits do not vest under ERISA but can be vested by contract, and that collective bargaining agreements are to be analyzed according to ordinary principals of contract law, in contrast to the Yard-Man decision; the Court disagreed with the Yard-Man inference, as collective bargaining agreements should be governed by ordinary contract law, and any inferences as to intent should be drawn from the specific facts; without specific evidence there should be no presumption that the parties intended to continue the benefits throughout retirement; durational clauses in collective bargaining agreements should govern and contractual obligations should generally cease on termination of the collective bargaining agreement; ambiguous writings should not be construed to create lifetime promises; the Court therefore rejected the Yard-Man inference, and this case was remanded for the lower court to apply ordinary principals of contract law to the facts; the decision, which was unanimous, was written by Justice Thomas, but there was a concurrence by Justice Ginsburg noting that in determining whether the parties intended to vest retiree health benefits implied terms of the agreement, e.g., whether the retiree health benefits were equated to pension benefits, should be examined, as should extrinsic evidence).

Thursday, October 23, 2014



Pension Plan and Related Limits
Pre-tax elective deferral maximum under IRC § 401(k), 403(b), and 457(b) plans
Age 50 and older “catch-up” adjustment for 401(k), 403(b), and governmental 457(b) plans and SEPs
Annual compensation limit under IRC §§ 401(a)(17), 404(l) and 408(k)
Annual benefit limit for defined benefit plans under IRC § 415(b)
Annual contribution limit for defined contribution plans under IRC § 415(c)
Highly compensated employee threshold for purposes of testing in the following year under IRC § 414(q)(1)(B)
Key employee threshold for top heavy plan under IRC § 416(i)
IRC § 430(c)(7)(D)(i)(II) amount for determining excess employee compensation for single-employer defined benefit plans where election has been made
ESOP account balance for five-year and one-year distribution rule under IRC § 409(o)(1)(C)(ii)
SEP pension compensation threshold under IRC § 408(k)
SIMPLE plan elective deferral limit under IRC § 408(p)(2)(E)
SIMPLE plan age 50 catch-up
Basic IRA/Roth IRA contribution limitation under IRC § 219(b)/§ 408A (age 50 $1,000 catch-up for IRAs does not have cost-of-living adjustment)
Phase-out for deductions for IRA for married couples filing jointly, in which the spouse who makes the IRA contribution is an active participant in an employer-sponsored retirement plan
$96,000 to $116,000
$98,000 to $118,000
Adjusted gross income (AGI) phase-out range for married joint filers taxpayers making contributions to a Roth IRA
$181,000 to $191,000
$183,000 to $193,000
AGI limit for retirement savings contributions (saver's) credit for married couples filing jointly
Health Savings Account contribution limits (single and family)
$3,300 and $6,550
$3,350 and $6,650
Maximum monthly benefit guarantee by PBGC
PBGC flat-rate premium for a single-employer plans (as amended by MAP-21 2012 legislation)
Taxable wage base subject to FICA tax