September, 1997, Special SupplementStephen H. Cypen, Esq., Editor
A REVIEW OF THE TAXPAYER RELIEF ACT OF 1997
As our readers know, on August 5, 1997 President Clinton signed into law P.L. 105-34, the Taxpayer Relief Act of 1997 (H.R. 2014). The Bill was passed by an overwhelming bipartisan majority: House, 389 to 43 and Senate, 92 to 8. The law contains over 800 Internal Revenue Code amendments and almost 300 new provisions, half of which are already effective. The new law is also memorable for another reason. It represents the first time a President has cancelled provisions from enacted legislation pursuant to his authority granted under the Line Item Veto Act (P.L. 104-130/April 9, 1996). Fortunately, the President's veto, which is subject to being overridden and to the possibility of a constitutional challenge, did not involve any of the provisions relating to state and local government pension plans.
What follows is a limited overview of the Act. Section I deals with provisions that directly affect some or all state and local government pension plans. Section II deals with other items of interest to state and local government plans. Of course, those parts of the first section dealing with (a) the extension of moratorium on nondiscrimination rules and (b) removal of dollar limitation on benefit payments for certain police and firefighters were briefly treated in the lead item of our August, 1997 Newsletter.
Title XV is entitled "Pensions and Employee Benefits." Subtitle A, "Simplification," comprises Sections 1501 through 1510, the following of which are summarized:
Sec. 1504. Modification of 403(b) exclusion allowance to conform to 415 modifications. Under present law, annual contributions to a Section 403(b) annuity cannot exceed the exclusion allowance. Generally, the exclusion allowance for a taxable year is the excess, if any, of (1) 20% of the employee's includible compensation multiplied by his or her years of service, over (2) the aggregate employer contributions for an annuity excludable for any prior taxable years. Alternatively, an employee may elect to have the exclusion allowance determined under the rules relating to tax-qualified defined contribution plans (Sec. 415). The new law conforms the exclusion allowance to the new Section 415 rules by including in compensation elective deferrals and any amounts contributed or deferred by the employer at the election of the employee under a cafeteria plan (Sec. 125) or a plan maintained by a tax-exempt organization or State or local government (Sec. 457) which are not includible in the employee's gross income. The modification to the definition of includible compensation is effective for years beginning after December 31, 1997.
Sec. 1505. Extension of moratorium on application of certain nondiscrimination rules to State and local governments. Currently the rules applicable to governmental plans require that such plans satisfy certain nondiscrimination and minimum participation rules. In general, rules require that a plan not discriminate in favor of highly compensated employees with regard to contribution and benefits provided under the plan, participation in the plan, coverage under the plan and compensation taken into account under the plan. Nondiscrimination rules apply to all governmental plans, qualified retirement plans (including Sec. 401(k) plans in effect before May 6, 1986) and annuity plans (Sec. 403(b) plans). The Internal Revenue Service has issued several notices which extend the effective date for compliance for governmental plans to the plan year beginning on or after January 1, 1999. The Act permanently exempts governmental plans from having to comply with the rules. The exemption is effective with respect to tax years beginning on or after August 5, 1997, and governmental plans will be retroactively treated as satisfying the coverage and nondiscrimination test for all tax years beginning before that date.
Sec. 1509. Clarification of disqualification rules relating to acceptance of rollover contributions. Present law provides that a qualified retirement plan that accepts rollover contributions from other plans will not be disqualified because the plan making the distribution is, in fact, not qualified at the time of distribution, if, prior to accepting the rollover, the receiving plan reasonably concluded that the distributing plan was qualified. The new law clarifies that it is not necessary for a distributing plan to have a favorable IRS determination letter for the receiving plan reasonably to conclude that the contribution is a valid rollover. The provision is effective for rollover contributions made after December 31, 1997.
Subtitle B is entitled "Other Provisions Relating to Pensions and Employee Benefits" and comprises Sections 1521 through 1530, the following of which are summarized:
Sec. 1525. Section 401(k) plans for certain irrigation and drainage entities. As you may know, State and local governments are prohibited from establishing Section 401(k) plans after May 6, 1986. Now, a mutual irrigation or ditch company is allowed to maintain a Section 401(k) plan even if such company is a State or local government organization. The law also applies to districts organized under the laws of a State as a municipal corporation for the purpose of irrigation, water conservation or drainage. The amendment is effective for years beginning after December 31, 1997. (Hey, don't knock this change -- it shows good lobbying.)
Sec. 1526. Portability of permissive service credit under governmental pension plans. Certain governmental plans allow employees to receive credit for periods of service not otherwise credited under the plan ("permissive service credit") if employee contributions are made in accordance with the plan. Previously, if these contributions were made on an after-tax basis, they were subject to the defined contribution limits of Section 415. There is now a choice, applicable only for permissive service credits that meet a specific definition, of taking these contributions into account using either defined contribution limits or defined benefit limits of Section 415. Also, the provision is not intended to affect the treatment of "pick up" contributions under Section 415 or to apply to purchases of service credit for qualified military service under rules relating to veterans' reemployment rights. The change is effective for contributions to purchase permissive service credits made in years beginning after December 31, 1997, but a transition rule applies for plans that provided for such purchase as of August 5, 1997.
Sec. 1527. Removal of dollar limitation on benefit payments from a defined benefit plan maintained for certain police and fire employees. Section 415 limits the annual defined retirement benefit to $125,000 (for 1997, indexed for inflation). In general, the dollar limit is reduced if benefits begin before Social Security retirement age and increase if benefits begin after Social Security retirement age. In the case of State and local government plans, the dollar limit is not reduced unless benefits begin before age 62 (and in any case to not less than $75,000) and the dollar limit is increased if benefits begin after age 65. For qualified police or firefighters, the dollar limit cannot be reduced below $70,000 (for 1997, indexed for inflation) regardless of the age at which benefits commence. Thanks to a Senate floor amendment, the reduction in the annual dollar limitation on retirement benefits for police or firefighters who retire before age 62 has been removed. Retirement after age 65 is still subject to the increased limitation (talk about the best of both worlds). The amendment is effective for years beginning after December 31, 1996.
Sec. 1528. Survivor benefits for public safety officers killed in the line of duty. Surviving spouses and surviving dependent children of military personnel killed in combat generally receive survivor benefits exempt from income taxation. However, except to the extent that benefits represent a return of after-tax employee contributions, survivor benefits paid under a governmental retirement plan to survivors of a law enforcement officer killed in the line of duty are taxable. (Survivor benefits paid under a government plan only to survivors of officers who died as a result of injuries sustained in the line of duty are in the nature of workers' compensation and are usually excludable from income. But there was some confusion as to whether or not a given payment was "in the nature of workers' compensation.") In any event, the law now excludes from income the survivor annuity benefits paid on account of the death of a public safety officer killed in the line of duty. "Public safety officer" is as defined in the Omnibus Crime Control and Safe Streets Act of 1968: police and law enforcement officers, firefighters and rescue squads, and ambulance crews. The exclusion does not apply if it is determined by the "appropriate supervising authority" that (1) the death was caused by the intentional misconduct of the officer or by the officer's intention to bring about the death, (2) the officer was voluntarily intoxicated at the time of death, (3) the officer was performing his or her duties in a grossly negligent manner at the time of death or (4) the actions of the individual to whom payment is to be made were a substantial contributing factor to the death of the officer (like, maybe, killing your spouse to get his or her pension). The provision applies to amounts received in tax years beginning after December 31, 1996, with respect to individuals dying after that date.
Sec. 1529. Treatment of certain disability benefits received by former police officers or firefighters. As we just said, amounts received under workers' compensation for personal injuries or sickness incurred in the course of employment are excluded from income. Such compensation received by survivors of a deceased employee is also excluded. Of course, nonoccupational benefits are not excludable from income as workers' compensation benefits -- and benefits received pursuant to an irrebuttable presumption that a particular condition is work-related are considered nonoccupational. But there is a change, albeit a narrow one, which excludes from income the compensation for heart disease and hypertension in the following circumstances. The individual must have been a full-time employee of a police department or a fire department (not necessarily a police officer or a firefighter, despite the caption of the section) organized and operated by a State or by any political subdivision of a State. State law, as of May 19, 1992, must have irrebuttably presumed that heart disease and hypertension are work-related illnesses, but only for employees separating from service before July 1, 1992 and receiving payments during 1989, 1990 or 1991. Finally, claims for refund or credit for overpayment of tax resulting from this provision may be filed by August 5, 1998, regardless of the otherwise-applicable statute of limitations. (What makes you think this amendment was designed to benefit only a very specific, identifiable group?)
Title X is entitled "Revenues." Subtitle E, "Provisions Relating to Tax-Exempt Entities," comprises Sections 1041 and 1042. Subtitle H, "Pension Provisions," comprises Sections 1071 through 1075. We summarize the following four sections of interest to state and local government plans:
Sec. 1042. Termination of certain exemptions from rules relating to exempt organizations which provide commercial-type insurance. Under the Tax Reform Act of 1986, a charitable organization (Sec. 501(c)(3)) or a civic league or other welfare organization (Sec. 501(c)(4)) providing commercial-type insurance is granted tax-exempt status only if no substantial part of its activities consists of providing such insurance. However, a special rule exempted Mutual of America and the Teachers Insurance Annuity Association-College Retirement Equities Fund (TIAA-CREF) so that the portion of their business attributable to pension business was not subject to tax. The Act repeals the special rules applicable to these two taxpayers and treats them for tax purposes as life insurance companies. The provision applies to tax years beginning after December 31, 1997, but the companies are granted a fresh start with respect to accounting method changes caused by the 1997 repeal.
Sec. 1071. Pension accrued benefit distributable without consent increased to $5,000.00. A qualified plan can pay the balance of a participant's account without that participant's consent if the present value of the benefit does not exceed $5,000.00. Previously, the limit was $3,500.00. The new limit applies to plan years beginning after August 5, 1997. Although the House Bill and the Senate amendment both provided for the $5,000.00 amount to be adjusted for inflation, curiously, the conference agreement makes no provision for such adjustment.
Sec. 1073. Repeal of excess distribution and excess retirement accumulation tax. Until now a 15% excise tax has been imposed on excess distributions from qualified retirement plans, tax-sheltered annuities and IRAs as well as an additional 15% estate tax on the excess accumulations in these plans remaining at death. Excess distributions are generally the aggregate amount of retirement distributions from such plans during any calendar year in excess of $160,000.00 (for 1997) or five times that amount in the case of a lump-sum distribution. Last year's Small Business Job Protection Act suspended the 15% excise tax for excess distributions received in 1997, 1998 and 1999. The new law repeals the 15% excise tax for payments received after December 31, 1996 and repeals the 15% additional estate tax for decedents dying after December 31, 1996.
Sec. 1075. Basis recovery rules for annuities over more than one life. Presently, the amount of an annuity payment from a contributory qualified plan that is not includible in an individual's income as recovery of basis (that is, the participant's contributions) is determined by dividing the total basis by the number of expected payments as provided in a table. The new law requires that the existing table now apply only to benefits based on the life of one annuitant. It adds a second table, which will apply to benefits based on the life of more than one annuitant (for example, a joint and survivor annuity). The change affects annuities with starting dates after December 31, 1997.
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