Florida Legislature Considers Exempting Participant Loans from State's Stamp Tax

Members of the Florida legislature recently proposed a change to the state's stamp tax law that would specifically exclude its application to participant loans from ERISA-covered retirement plans ("participant loans"). This proposal, and the exploration of its revenue impact, suggests that the Florida legislature is aware of the confusion for retirement plans created by the state's stamp tax.   Background.  Florida state law establishes a "stamp tax" on loans that are made, executed or delivered in Florida. (SeeChapter 201.08(1) of the Florida Statutes.) The applicable tax rate on loans is $.35 for each $100 borrowed, or $175.00 on a $50,000 loan. The Florida Department of Revenue ("DOR") has previously confirmed that the stamp tax applies to participant loans. (See Tax Information Publication # 00B04-06.) The Florida stamp tax statute specifically provides that in the event any party to a covered transaction is exempt from paying the stamp tax, the tax must be paid by the nonexempt party. Financial Impact of Exemption. At a Revenue Estimating Conference that took place on February 20, 2014, the Florida legislature reviewed the financial impact of the proposed exemption. It was estimated that this exemption would result in a first-year loss in revenue to the state of approximately $6,200,000.00. NOTE: This estimate was not based on any historical data of actual collections of stamp tax revenue attributable to retirement plan loans. Rather, the estimate was based on national averages of plan assets and outstanding retirement plan loans. Enforcement of the Stamp Tax. The Florida DOR does not have a viable means of enforcing the law as applied to participant loans. Documents associated with participant loans are not public record. Moreover, because there is no state individual income tax in Florida, there is no related disclosure on a state income tax form of receipt of a participant loan or the default of a participant loan. Absent the Florida DOR's unprecedented audit of a retirement plan, it is unlikely that the existence of a participant loan would be discovered. Consequences of Noncompliance with Stamp Tax. Among the consequences of the failure to comply with Florida's stamp tax is that the loan is unenforceable in Florida state courts. Therefore, the failure to pay the stamp tax on a participant loan may result in a prohibited transaction and/or tax qualification failure, as well as a deemed distribution due to the potential inability of the plan to enforce its rights in court in the event of a default, in violation of the enforceable agreement requirement articulated in applicable IRS regulations. (See Treas. Reg. Section 1.72(p)-1.) Because a participant loan is generally limited to 50% of a participant's plan account balance and secured by the participant's remaining account balance, which may be foreclosed upon on default and after the participant's severance from employment, without court intervention, it would seem a participant loan is adequately enforceable regardless of whether court intervention is precluded due to failure to pay the Florida stamp tax. In any event, plan sponsors are extremely unlikely to pursue relief for a plan loan default in court.   ERISA Preemption.  Various opinions exist as to whether ERISA preempts the Florida stamp tax statute with respect to participant loans. Since this issue has yet to be litigated, there is no clear guidance. Courts have previously held that ERISA preempts a state law that specifically and exclusively targets ERISA-covered plans. However, courts have been hesitant to find that ERISA preempts state laws more general in nature. In fact, state laws of general applicability with only a tangential impact on ERISA plans (and even state laws specifically, but not exclusively, related to ERISA plans) have commonly been found to not be preempted by ERISA. A recent example of this would be a California law that established an unrelated business income tax that was determined by the Second Circuit Court of Appeals to not be subject to preemption by ERISA despite its application to ERISA-covered retirement plan trusts. (See Hattem v. Schwarzenegger, 2d Cir., No. 05-3926-cv, 5/23/06.) Courts have articulated that the purpose behind ERISA's preemption clause is to "enable employers to establish a uniform administrative scheme, which provides a set of standard procedures to guide processing of claims and disbursement of benefits." Thus, it may be reasonable to conclude that because the stamp tax may apply in a non-uniform manner to some plans (as the tax would apply to some borrowing participants (i.e., Florida residents) but not others (i.e., non-Florida residents)), that it should be preempted by ERISA. It can be argued that while ERISA preemption might prevent assessment of the stamp tax on the plan, the plan sponsor or plan administrator, it does not prevent its assessment on the borrowing participant. Conclusion.  It is reasonable to conclude that, based on the general applicability of the Florida stamp tax statute and recent jurisprudence related to ERISA preemption, participant loans from ERISA-covered retirement plans are subject to the Florida stamp tax. If you think this tax applies to your plan or a participant in your plan, please contact us for assistance.

Here are the 2015 Cost of Living Adjustments

	2014	2015
Maximum annual payout from a defined benefit plan at or after age 62 (plan year ending in stated calendar year)	$210,000*	$210,000*
Maximum annual contribution to an individual's defined contribution account (plan year ending in stated calendar year)	$52,000**	$53,000**
Maximum Section 401(k), 403(b) and 457(b) elective deferrals (under Code Section 402(g))	$17,500***	$18,000***
Section 414(v)(2)(B)(i) catch-up limit for individuals aged 50 and older	$5,500***	$6,000***
Maximum amount of annual compensation that can be taken into account for determining benefits or contributions under a qualified plan (plan year beginning in stated calendar year)	$260,000	$265,000
Test to identify highly compensated employees, based on compensation in preceding year (plan year beginning in stated year determines "highly compensated" status for next plan year)	$115,000	$120,000
Wage Base For Social Security Tax	$117,000	$118,500
Wage Base For Medicare	No Limit	No Limit
Amount of compensation to be a "key" employee	$170,000	$170,000

 

* There are late-retirement adjustments for benefits starting after age 65.

** Plus "catch-up" contributions.
*** These are calendar year limitations. 

DOL Issues New Guidance on Locating Missing Participants

The U.S. Department of Labor ("DOL") has provided new guidance to plan fiduciaries of terminated defined contribution plans for locating missing or unresponsive participants in order to distribute their benefits.  The guidance, which comes in the form of Field Assistance Bulletin ("FAB") 2014-0, replaces the prior guidance provided in FAB 2004-02.

FAB 2014-01 outlines the mandatory steps that plan fiduciaries must take to discharge their duty to locate missing participants and provides acceptable options for distributing a benefit when participants remain unresponsive.

Background.  The inability to locate and make distributions to participants when terminating a retirement plan can present several quandaries for plan fiduciaries, including:

• Delaying the filing of the plan's final Form 5500.  All plan assets must be distributed from the plan's trust before a final Form 5500 can be filed.
• Voiding a favorable determination letter issued by the Internal Revenue Service ("IRS") in relation to the plan's termination.  In order to rely on an IRS determination letter, a plan administrator must make final distributions within a reasonable time following the plan termination.
• The Internal Revenue Code's mandate that fiduciaries must seek affirmative direction from plan participants when making termination distributions.

Prior Guidance.  To address these concerns, in 2004 the DOL released FAB 2004-02.  FAB 2004-02 provided plan fiduciaries with guidance on how to meet their obligations under ERISA to locate and distribute benefits to missing participants in the context of a defined contribution plan termination.  FAB 2004-02 advised plan fiduciaries to use the following methods to locate missing participants:

• Send notices by certified mail;
• Review related plan and employer records;
• Contact the participant's designated beneficiary; and
• Use the letter-forwarding services of the IRS or Social Security Administration ("SSA").

Internet search tools, commercial locator services and credit reporting agencies were also recommended as search resources.  FAB 2004-02 relied heavily on the IRS and SSA letter-forwarding programs.  Both of these programs, however, were recently discontinued.  (The SSA program ended in May of this year, and the IRS excluded retirement plans from its program effective August of 2012.)

DOL Safe Harbor Regulations.  In 2006, DOL issued regulations to provide fiduciaries of terminating defined contribution plans with "safe-harbor" procedures for making distributions to participants who do not affirmatively request distributions.  (See ERISA Regulation Section 2550.404a-3.)  These regulations specify the content and manner for providing notice to missing participants, as well as various options for distributing an unresponsive participant's account balance.  Distribution options include transferring the participant's account balance to:

• an interest bearing bank account;
• an individual retirement account ("IRA") in the participant's name; or
• the unclaimed property fund of the state in which the participant was last known to reside.

FAB 2014-01.  FAB 2014-01, which supersedes FAB 2004-02, reflects certain changes that have occurred over the last decade, including the expansion of internet search tools and the discontinuance of the IRS and SSA letter forwarding programs.  Similar to the prior guidance, FAB 2014-01 requires plan fiduciaries to take certain steps to locate missing participants in a terminated defined contribution plan and outlines certain additional steps that, in the DOL's opinion, plan fiduciaries must consider to fully discharge their duties under ERISA.

ERISA 404(a) requires plan fiduciaries to act prudently and solely in the interest of plan participants and beneficiaries. While DOL views the decision to terminate a retirement plan as a "settlor" function not regulated by ERISA, it maintains that steps taken to implement this decision are fiduciary activities, including steps taken to locate missing participants and distribute unresponsive participants' account balances.  Thus, FAB 2014-01 notes that in accordance with their duties of prudence and loyalty, plan fiduciaries must take reasonable steps to locate missing participants.

Required Search Steps.  Where plan fiduciaries are unable to locate participants through routine delivery methods, such as first class mail or electronic notice (i.e., e-mail), FAB 2014-01 indicates that plan fiduciaries must take the following steps (before concluding their search efforts for the missing participants):

• Send notices by certified mail;
• Review related plan and employer records;
• Contact the participant's designated beneficiary; and
• Use free electronic search tools (e.g., internet searches, public records databases, etc.).

DOL considers the failure to take these steps as a breach of fiduciary duty.

Additional Search Steps.  If all four required search methods are unsuccessful, plan fiduciaries must determine whether additional steps are appropriate.  In making this determination, plan fiduciaries must consider the size of a participant's account balance and the cost of further search efforts.  Additional steps include fee-based Internet search tools, commercial locator services, credit reporting agencies, information brokers, and investigation databases and similar services that may include charges. 

NOTE:  DOL maintains the position that plan fiduciaries may charge missing participants' accounts for search-related costs, provided the charges are reasonable.

Distributing an Unresponsive Participant's Account.  Where a missing participant remains unresponsive, a plan fiduciary must determine the appropriate method for distributing that participant's account balance.  FAB 2014-01 establishes a range of options for distributing benefits to unresponsive participants after a plan fiduciary has exhausted the search efforts described above.  Specifically, FAB 2014-01 identifies a preferred method and two alternative methods for consideration if the preferred approach is not viable.

NOTE:  These methods are the same as those provided under the DOL's 2006 safe-harbor regulation.

The preferred method for distributing a missing participant's account is to roll over the benefit to an IRA established in the participant's name.  DOL prefers this method because it avoids immediate taxation of the benefit and it is the option most likely to preserve the benefit.

NOTE:  Because the selection of an IRA provider and the manner in which the benefit will be invested in the IRA are fiduciary actions, plan fiduciaries are advised to rely on the DOL's 2006 safe-harbor regulations when effectuating rollovers missing participants' accounts to IRAs. 

Alternative methods for distributing a missing participant's account include:

• transferring the benefit to an interest-bearing account (in the name of the missing participant) in a federally insured bank; or
• transferring the benefit to a state unclaimed property fund. 

When deciding between these two options, the plan fiduciary must consider the attendant facts and circumstances, including bank charges, interest rates, and the process for searching the state's unclaimed property fund.  Before deciding to take either of these steps, however, the plan fiduciary must first conclude that using these methods is appropriate despite the adverse tax consequences to participants as opposed to the tax-free rollover to an IRA.

FAB 2014-01 clarifies that 100% income tax withholding is not an acceptable method for distributing a missing participant's account balance.  In the past, plan fiduciaries have withheld 100% of a missing participant's distribution, thereby essentially turning the benefit over to the IRS.  The DOL has confirmed that this method is objectionable because it does not necessarily result in an offset to the participant's income taxes and can deprive a participant of his or her benefit. 

Action Steps for Plan Fiduciaries.  Plan fiduciaries should review their plan procedures for missing participants and amend them, if needed, to conform to FAB 2014-01's guidance.  In addition, plan administrators should be sure to thoroughly document all steps taken to locate and make distributions on behalf of missing participants. 

While FAB 2014-01 specifically applies to locating missing participants in connection with a defined contribution plan termination, it may provide useful guidance in other similar circumstances involving missing participants, such as un-cashed checks and required minimum distributions.

Supreme Court Rejects Presumption of Prudence in Stock-Drop Cases

Recently, the Supreme Court handed down a unanimous opinion in the case of Fifth Third Bancorp v. Dudenhoeffer, rejecting a long-standing rule that  fiduciaries of individual account plans are entitled to a "presumption of prudence" when employer stock is offered as an investment option.  The Court's ruling impacts 401(k) plans that offer employer stock as an investment option as well as employee stock ownership plans that invest primarily in employer stock. 

Many employers offering employer stock as an investment option in a 401(k) plan have been subject to class action lawsuits arising from a substantial drop in their stock price causing participants to claim that the employer breached its duty of prudence and loyalty by allowing continued investment in the stock.  Prior to the recent Supreme Court ruling inDudenhoeffer, a key defense for employers in  "stock-drop" suits was the so-called "Moench presumption" of prudence, named after the 1995 decision by the Third Circuit Court of Appeals in Moench v. Robertson which was followed by a majority of Circuit Courts.

Application of the Moench presumption meant that a plan fiduciary's decision to remain invested in employer securities is presumed to be reasonable, unless the plaintiff can show that the fiduciary abused its discretion in continuing to make employer stock available as an investment alternative.   The rationale for the Moench presumption was based on an attempt to balance competing policy concerns that, on the one hand, would promote employee ownership, and on the other, protect participants against imprudent plan investments.  Thus, while ERISA requires fiduciaries to diversify plan assets and to act with prudence in making investment decisions, it also provides that in the case of plans offering employer stock as an investment, they are exempt from the duty to diversify investments and are also exempt from the prudence requirement, but only to the extent that prudence would require diversification. 

Lower Court's Decision.  The Dudenhoeffer case involved a 401(k) plan sponsored by Fifth Third Bancorp, which offered the company's stock as a plan investment option.  From July 2007 to September 2009, the stock's price dropped 74%, causing the plan to lose "tens of millions" of dollars, allegedly as a result of Fifth Third Bancorp's shift from conservative lending practices to being a subprime lender.  Participants filed a class action lawsuit in federal district court against Fifth Third Bancorp alleging that plan fiduciaries breached their duty under ERISA by continuing to include Fifth Third Bancorp stock on the plan's investment menu despite the fact that they knew or should have known that the company's business model put its value in jeopardy.

The District Court dismissed the claim on the basis that the fiduciary's decision was presumed to be prudent.  On appeal, however, the Court of Appeals overturned the District Court and ruled that the presumption is to be applied at a later stage in the litigation when there is a more fully developed court record.  The ruling by the Appeals Court inDudenhoeffer was at odds with the majority of courts which apply the presumption in the initial stage of litigation, meaning that in most stock-drop cases, participants are denied the opportunity to engage in discovery. 

The Sixth Circuit also ruled that to rebut the presumption, participants need only show that a prudent fiduciary acting under similar circumstances would have made a decision that the employer stock was an imprudent investment.  This ruling was also a departure from the majority as most courts require that a participant must demonstrate that the company was in "dire circumstances" or facing "impending collapse" in order to rebut the presumption.  The Appeals Court specifically rejected these "narrowly defined" tests for rebutting the presumption in favor of one that is easier for participants to prove.

Supreme Court Decision.  The Supreme Court vacated the Sixth Circuit's decision and directed the Sixth Circuit to reconsider whether the complaint inDudenhoeffer states a "plausible" claim for a breach of fiduciary duty.  In reaching its decision, the Court held that there is no "presumption of prudence" in favor of ESOP fiduciaries as there is no basis in ERISA that supports a special presumption of prudence for decisions made by ESOP fiduciaries.  Instead, an ESOP fiduciary's decision is subject to review under the same duty of prudence applicable to all ERISA fiduciaries, except that ESOP fiduciaries have no duty to diversify plan investments. While ESOP fiduciaries are not liable for losses that result from a failure to diversify, they are required to act with the care, skill, prudence and diligence that a prudent expert acting in like capacity and familiar with such matters would use to make and continue to hold the investment of employer stock.

According to the Court, in order to a claim for a breach of fiduciary duty, the claim must be based on plausible factual allegations of breach of fiduciary duty.  Where a stock is publicly traded, allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and thus, are insufficient to state a claim.  Further, the Court instructs that in order for a complaint to state a claim for a breach of the duty of prudence, a plaintiff must plausibly allege an alternative action that the defendant could have taken, that would have been legal and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the trust than to help it.  In so ruling, the Court held that a fiduciary's duty of prudence does not require a fiduciary to break the law and buy or sell company stock on the basis of insider information. 

One of the arguments advanced by Fifth Third Bancorp was that without the Moench presumption, an ESOP fiduciary would be subject to costly duty-of -prudence "meritless lawsuits" every time there was a drop is stock price.  The Court recognized this concern but concluded that the Moench presumption was an inappropriate way to weed out "meritless lawsuits."  Instead, the Court stated that the more important mechanism for weeding out meritless claims requires a "careful judicial consideration of whether the complaint states a claim that the defendant has acted imprudently."  Thus, courts must carefully scrutinize stock-drop complaints to determine whether they state a plausible claim for breach of fiduciary duty.

Implications.  Even though the Supreme Court specifically rejected the application of the Moenchpresumption, plaintiffs still face a high burden as they must plead specific facts in order to survive a motion to dismiss, such as the specific alternate action that the fiduciaries should have taken.  In addition, the Court has given ESOP fiduciaries several potential defenses as, according to the Court, they can rely on the stock market price as the best estimate of stock price.  Complying with the rules on insider trading is yet another potential defense a fiduciary can raise.  Finally, plan sponsors may want to consider the composition of their investment committees and whether an independent third party fiduciary should be hired to make the decision whether to continue to invest in or offer a company stock fund as an investment option.

IRS Issues Final Regulations to Clarify Tax Treatment of Payments by Retirement Plans for Accident, Health and Disability Insurance Premium

The IRS has issued final regulations that clarify the tax treatment of premium payments paid by qualified defined contribution plans for accident and health insurance where such payments are charged against participants' plan accounts.  Included within the final regulations is a new rule governing the tax treatment of premiums paid by defined contribution plans (and charged against participants' account) for disability insurance that provides replacement plan contributions when a participant becomes disabled.  The final regulations are effective for plan years beginning on or after January 1, 2015, but taxpayers may elect to apply the regulations to earlier taxable years.

Background.  Section 125 of the Code allows employees to pay accident and health insurance premiums on a pre-tax basis.  The Code also excludes from a participant's taxable income all proceeds received under accident or health insurance policies for injuries or sickness.  Additionally, Code Section 402(a) provides that distributions from qualified retirement plans are taxable to the participant in the year of distribution.  

Accident or Health Insurance Premiums.  The final regulations reiterate that, as a general rule, premium payments made from qualified defined contribution plans for accident or health insurance (including long-term care) are considered taxable distributions to the insured participant during the year in which the premium payments are made.  Certain statutory exceptions to this general rule exist, including: (i) premiums payments made on behalf of qualified public safety officers (Code Section 402(l)), and (ii) premium payments from a qualified retiree health account (Code Section 401(h)).  

Premium payments that are charged against a participant's defined contribution plan account are treated as a taxable distribution and are deemed as being made by the participant, not the employer.  In other words, the transaction is the same as if the participant purchased the coverage with after-tax dollars.  Therefore, proceeds received from an insurance policy whose premiums are paid by a qualified plan are generally excludable from the participant's gross income. 

NOTE: Where a participant took deductions for the insurance premium distribution, the insurance proceeds would be taxable.

Disability Insurance Premiums.  The final regulations provide that premium payments made by a qualified defined contribution plan for disability insurance that provides replacement plan contributions in the event of the participant becoming disabled are not treated as a taxable distribution to the participant if the following conditions are met:

• The insurance policy provides for proceeds to be paid to the plan if the employee becomes unable to continue employment because of disability;
• Proceeds from the insurance policy are credited to the participant's plan account; and
• The amount payable under the insurance policy does not exceed the reasonably expected annual contributions that the participant would have made or received during the period of disability, reduced by any other contributions made on the employee's behalf during the disability period.  (Future salary increases that the participant would otherwise have received during the period of the disability may be considered in determining the "reasonably expected" amount of the contribution that the participant would have made.)

Disability insurance policies that meet these conditions are treated as plan investments and any proceeds received are treated as a return on that investment as opposed to plan contributions.  Thus, proceeds from the disability insurance policy are not subject to Code rules that limit annual plan contributions.  In addition, insurance proceeds are not taxable to the participant at the time of payment.

The final regulations advise that the contribution disability insurance policies can replace:

• Pre-tax contributions that a participant would otherwise have made during the period of disability;
• Any related employer-paid matching contributions the employee would have received; and
• Any employer non-elective (or profit sharing) contributions.

Action Steps for Employers.  Employers that sponsor qualified defined contribution plans should carefully consider whether to provide employees with the option to purchase contribution disability insurance through the plan on a tax-favored basis.  Offering such disability insurance as a plan investment option is a fiduciary decision that will expose the employer to the risk of fiduciary liability.  Accordingly, employers that decide to offer disability insurance are advised to engage in an objective, thorough and analytical process to identify and select the right disability insurance policy. 

Before an employer decides to offer contribution disability insurance as an investment option under its qualified defined contribution plan, the underlying plan document must be reviewed to determine what amendments are needed.  Employers are advised to engage qualified employee benefits counsel to assist in the plan document review and amendment process. 

NOTE:  Marcia Wagner testified before the Internal Revenue Service regarding the appropriate treatment of disability insurance in the context of defined contribution plans and the very position that she espoused, by virtue of the regulations, is now the law of the land. 

IRS Issues Updated Circular 230 Regulations

The IRS has issued updated final regulations on Circular 230 that significantly revise the manner in which practitioners are required to advise on federal tax matters.  Circular 230 is a portion of the federal regulations that governs the conduct of individuals who practice before the IRS.  Practitioners who violate Circular 230's rules of conduct are subject to disciplinary actions ranging from monetary sanctions to suspension and disbarment from practice before IRS. 

This article primarily focuses on the final regulations' elimination of the covered opinion rules and the new requirements for written tax advice.  Specifically, the new regulations provide practitioners with relief from Circular 230's previously onerous rules, thereby replacing them with a more workable standard of care that is based on facts and circumstances.  Because the penalties for failing to meet Circular 230's requirements can be severe, practitioners must be aware of, and comply with, the updated regulations.

Covered Opinions.  The most significant change under the updated regulations is the elimination of the distinction between a "covered opinion" and other written tax advice.  The prior regulations provided very distinct rules depending upon which of these two categories of writing the advice was classified.  In fact, the rules on covered opinions were very complex and imposed onerous due diligence requirements that might exceed a client's expectations, whereas the rules for written advice not deemed as a covered opinion were far less stringent.

Because of the stricter requirements for covered opinions, practitioners made every effort to avoid inadvertently providing covered opinions to their clients.  To avoid  penalties relative to covered opinions under Circular 230, practitioners would include a generic disclaimer (i.e., a "Circular 230 disclaimer") at the bottom of emails and other correspondence which provides that tax advice is not being offered to the reader.  These disclaimers were often provided without narrow tailoring to the particular advice provided to the client and even where the correspondence did not involve a tax matter.

Recognizing that the covered opinion rules created onerous compliance obligations for tax practitioners while providing little benefit to taxpayers, the updated regulations provide a single, uniform set of rules governing all written advice furnished on federal tax matters.          

New Rules for Written Tax Advice.  The new rules governing written tax advice strive to maintain standards that require practitioners to act ethically and competently while remaining practical and flexible in view of today's practice environment.  Under the updated regulations, practitioners must satisfy all six of the following requirements when rendering written advice on a federal tax matter:

1. Base the written advice on reasonable factual and legal assumptions;
2. Reasonably consider all relevant facts and circumstances that the practitioner knows or reasonably should know;
3. Use reasonable efforts to identify and ascertain the facts relevant to the advice;
4. Not rely on the representations of others if reliance on them would be unreasonable;
5. Relate applicable law and authority to facts; and
6. Not take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit.

The updated regulations explain that the determination of whether a practitioner has met these requirements will be based on all facts and circumstances attendant to the matter, including those not contemplated by the written advice. 

Exclusions from Written Advice.  The updated regulations contain exclusions from what constitutes written advice.  For example, government submissions on matters of policy (e.g., commentary submitted to the IRS in response to proposed regulations) are not considered written advice.  Continuing education presentations that are provided to an audience solely for enhancing knowledge on federal tax matters are also generally excluded, unless such presentations promote or market transactions.   

Reasonable Practitioner Standard.  IRS will apply a reasonable practitioner standard when reviewing practitioners' compliance with the updated regulations.  The updated regulations identify situations where it is unreasonable for a practitioner to rely on the representations of others (in violation of Circular 230).  Specifically, it is unreasonable for a practitioner to rely on a representation if the practitioner knows or reasonably should know that a representation or assumption on which the representation is based is incorrect, incomplete or inconsistent.  Also, reliance is unreasonable where the practitioner knows or reasonably should know that:

1. the opinion of the other person should not be relied upon,
2. the other person lacks the necessary qualifications to provide the advice, or
3. the other person has a conflict of interest in violation of Circular 230.

NOTE: Practitioners should be aware that the requirement for reasonable reliance on others may create an obligation to inquire as to the advisor's qualifications and background.

In the case of written advice that the practitioner knows or has reason to know will be used by another in promoting, marketing or making recommendations to another taxpayer, IRS will give heightened emphasis to the additional risk caused by the practitioner's lack of knowledge of the taxpayer's particular circumstances. 

  

Conclusion.  The final regulations, which became effective June 12, 2014, provide welcome relief to tax practitioners and clients alike by simplifying the rules for providing clients with written advice on federal tax matters.  However, due to the subjective nature of the new rules, tax advisors who furnish written advice must ensure that they can demonstrate that their advice is reasonable in light of the surrounding facts and circumstances. Nonetheless, tax practitioners no longer need to incorporate Circular 230 disclaimers into their written correspondence.

ERISA's 40th Anniversary

This week marks the 40th anniversary of a landmark event that, along with Social Security, has shaped the retirement landscape in the United States. President Gerald Ford's signing into law of the Employee Retirement Income Security Act (otherwise known as ERISA) on September 2, 1974 is largely responsible for the evolution of the private retirement plan system. With 401(k) plans as its mainstay, ERISA has been largely successful in delivering broad-based retirement security to employees, as well as providing for a uniform, nationwide set of fiduciary and administrative standards.

Today, this system is being questioned, if not threatened, because of the perception that its coverage is limited and does not result in retirement readiness for those it does cover. This criticism is short-sighted, since it ignores the system's positive achievements and neglects how it has adapted to meet the needs of a modern, mobile workforce. The best way to ensure the retirement security of Americans is to preserve this system and improve it with better plan design and financial products.

The event that crystalized the need for pension plan reforms was the 1963 closing of Studebaker Corporation's automobile plant which caused many long-service workers to lose both their jobs and benefits promised under the company's poorly funded defined benefit pension plan. ERISA addressed the concern that private pension plans were mismanaged by setting new standards for the vesting and funding of benefits, introducing new reporting and disclosure rules and imposing certain standards of conduct on fiduciaries who manage plans. Subsequent legislation would amend ERISA in important ways, such as reducing the maximum age that a plan may require for participation and creating spousal rights through mandatory survivor annuities and qualified domestic relations orders in the event of divorce.

These reforms established the groundwork for the explosive growth of the private plan system. According to Department of Labor records, in 1975 this system covered not quite 45 million participants; however, by 2011 it had expanded to include nearly 130 million people. Over the same period, the growth in plan assets has been even more impressive, rising from $260 billion to $6.3 trillion, a more than 24 fold increase.

ERISA's original focus was on making defined benefit plans more secure for participants. These plans promise periodic payments for life, the amount of which is determined by a formula whose key variables include a participant's compensation and length of service. Since the plan mandates a specified level of benefits, it is the employer's responsibility to make sufficient contributions to fund this lifetime commitment.

In the 1980s, the prevalence of the defined benefit model began to give way to individual account plans which, as their name implies, provide a benefit equal to an account consisting of employer and/or employee contributions and their earnings. These defined contribution plans, which include the now familiar 401(k) plan, appealed to employers, because of the relief they provided from the investment risk associated with defined benefit plans. On the heels of the 401(k) plan came the hybrid plan, also known as a cash balance plan, which allowed considerably higher contributions helping participants build their nest eggs quickly.

Since defined contribution accounts were portable, this alternative also made sense for a workforce that changed jobs with increasing frequency. Moreover, highly mobile workers were better off, because defined contribution plans tended to have shorter vesting periods than their defined benefit counterparts. By the early 1990s, defined contribution plans had overtaken defined benefit plans in terms of assets and plan participants, a trend that has continued until they now predominate.

           

Notwithstanding its popularity and the fact that approximately 74 percent of full-time workers in private industry have access to a retirement plan of some sort, the private retirement system, as presently constituted, has been criticized for a lack of access by part-time employees and those working for small employers who are reluctant to establish a plan. Other complaints center on the investment risk now being shouldered by a workforce without a high level of financial literacy. One example of this issue was the Studebaker-like scandal that occurred in 2001 when Enron plan participants were unable to diversify their excessive holdings in employer stock. Critics also say that, even if plan participants accumulate an adequate level of retirement assets, they run the risk that they will outlive them.

The beauty of the private retirement system under ERISA is its ability to adapt to meet employees' needs. Automatic enrollment and automatic escalation of employee contribution levels (with the ability to opt out) are already being used to improve the take-up rate of employees who have plan access and can be enhanced by wider use, as well as legislation that would make them more effective. For workers without plan access, legislation could authorize these same techniques to overcome employee inertia in making contributions to IRAs.

Further, small employers could be encouraged to establish retirement plans for their employees by means of tax incentives, authorizing simpler plan designs that eliminate burdensome nondiscrimination testing of the relative amounts deferred by high and low wage earners and deeming certain of an employer's fiduciary duties satisfied in certain circumstances.

The issue of investment risk is being addressed by the further development and wider use of investment products that automatically diversify and rebalance plan accounts, a concept already legislatively approved and in use in the form of qualified default investment alternatives.

To promote lifetime income options, proposed regulations would require disclosure to participants of the level of periodic income that could be supported by their plan accounts, and work is underway to remove regulatory barriers to offering annuity options in 401(k) plans. In addition, longevity annuities with a lifetime income stream beginning as late as age 85 are now permitted, so that participants can manage a portion of their retirement assets until an advanced age and still have assurance that their retirement assets will not run out. To address participant resistance to committing assets to an annuity, consideration is being given to developing a 401(k) plan default investment in the form of a trial annuity with an opt-out clause.

ERISA critics would supplement the private retirement plan system with an expansion of Social Security or various government-controlled retirement programs that would diminish support for employer-provided plans and could eventually crowd them out. But these alternatives are flawed and do not offer the advantages of the current system. For example, Social Security is already under financial strain, and even if this were not the case, its expansion would reduce the low national savings rate, given that Social Security revenues are immediately spent by the government and the program's putative pre-funding is a special government bond on which a future generation will have to make good.

Other proposals currently in vogue aim to provide universal pension coverage for privately employed workers under programs run by the federal or state governments. These programs would provide for contributions at an annual rate that is only half the average rate currently enjoyed by participants under the current system, effectively downsizing retirement benefits when we should be thinking of increasing them. The proposals for government controlled systems also entail such unappealing features as taxpayer-subsidized investment returns and carry the potential for misallocating assets due to political pressure. Moreover, each program would require special dispensations from ERISA's fiduciary requirements, fracturing the nationwide scope of their application.

The private retirement plan system has been successful in providing and safeguarding retirement benefits for millions of Americans. It has demonstrated the capacity for growth and change that bodes well for meeting the needs of the future. As we celebrate ERISA's achievements, we should realize that the system it was designed to foster is the appropriate vehicle for ensuring that all Americans are retirement ready.