The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "Act") was signed by the President on April 20, 2005.
The Act is generally effective with respect to bankruptcy filings made after October 17, 2005, although some provisions (including those discussed in the Executive Compensation Section, below) are effective immediately. Certain changes will directly affect administration of plan loans:- The automatic stay in bankruptcy, which prevents the collection of certain debtor obligations during bankruptcy, will not apply to stop a debtor’s preexisting payroll withholding authorization to repay a qualified plan loan.
- The debtor’s obligation to repay a qualified plan loan will not be discharged in bankruptcy.
- A Chapter 13 reorganization plan is prohibited from materially altering the terms of the qualified plan loan and amounts required to repay it will not be considered "disposable income." For this purpose, "disposable income" refers to the income of an individual in Chapter 13 reorganization that may be directed by the reorganization plan to be used to repay debt.
Expanding the protection for qualified retirement plan assets provided by the 1992 Patterson v. Shumate Supreme Court decision, the Act also permits an individual debtor to exempt from the property of the bankrupt estate certain tax-exempt retirement funds, such as funds in Code Section 403(b) annuities, traditional IRAs under Code Section 408, Roth IRAs under Code Section 408A, multiemployer plans under Code Section 414, and governmental and exempt organization plans under Code Section 457. An inflation-adjusted $1 million cap is imposed on the total value of an individual debtor’s interest in an IRA (not including certain rollover amounts) (other than a SEP or SIMPLE plan) or Roth IRA that may be claimed as exempt property (this cap may be increased by the court if the interests of justice so require).
The Supreme Court has extended some additional protection to IRAs.
The Court’s decision in Rousey v. Jacoway issued on April 4, has been touted as declaring that IRAs are exempt from Bankruptcy in the same way as qualified plans were determined to be exempt in the 1992 Patterson v. Shumate case. In fact, in this ruling involving bankruptcy law in effect before the Act described above, the Court remanded to the Circuit Court the matter of whether or not the right to receive payments from the IRA has been withheld from the bankrupt estate only to the extent it is "reasonably necessary to support" the debtor and/or his or her dependents. This test is applicable under pre-Act federal law to IRAs but does not apply to qualified plan benefits. Section 224(e) of new bankruptcy Act exempts (without the "means" test applied under prior law) the first $1 million of traditional and Roth IRA balances not attributable to certain rollover amounts, i. e., rollovers under Code Sections 402(c) (rollovers from qualified plans), 402(e)(6) (trust to trust transfers from qualified plans), 403(a) or (b) (rollover or trust to trust transfer from a qualified annuity plan), and 403(b)(8) (rollover from 403(b) annuity).As this and the previous item illustrate, the relationship between retirement plans and bankruptcy law remains complex and merits advance planning.
The Department of Labor’s Employee Benefits Security Administration ("EBSA") has simplified and expanded its Voluntary Fiduciary Correction Program ("VFC Program").
This is the program that permits employers voluntarily to correct violations of ERISA. It typically requires full correction of any violations and restoration to the plan of any losses or profits (with interest), and distribution to participants of any additional benefits owed them as part of the correction. The corrections are allowed upon payment of a penalty and a "no action" letter may then be obtained from EBSA. Correction stops the accumulation of large potential penalty assessments otherwise provided by law.The enhancements to the VFC program include three new eligible transactions dealing with illiquid plan assets sold to interested parties, participant loans that violate certain plan restrictions on loans, and delinquent participant loan repayments. Also added are a model application form, streamlined requirements for eligibility and documentation, and an online calculator for figuring the amounts to be restored to plans.
Employee Welfare Benefit Plans: April 2005 Developments
IRS explains HSA contribution rules for married taxpayers.
New Revenue Ruling 2005-25 addresses the situation of a married individual who has high deductible health plan ("HDHP") coverage when his or her spouse has non-HDHP coverage. IRS concludes that the married individual in this case (with the HDHP coverage) may contribute to an HSA, as long as the individual is not covered by the spouse’s non-HDHP.IRS confirms that HRAs cannot allow cash outs of unused amounts.
Health reimbursement arrangements ("HRAs") are funded solely by employer contributions and unused amounts may be carried over to the following year. The rules provide that HRAs may not allow participants to receive cash or any benefit other than the reimbursement of qualified medical expenses. In Revenue Ruling 2005-24, four situations were considered, of which three were found to violate this rule because they directly or indirectly permitted the cash out of benefits. Of the three situations determined to violate the rule, one provided for a direct cash out to the participant, the second allowed a cash out to the participant’s beneficiary after the participant’s death, and the third allowed participants to elect in advance to forfeit unused amounts and receive a cash payment or retirement plan contribution equal to the forfeiture.The fourth situation was found not to provide a prohibited cash out. Under it, HRA balances remained available until they were exhausted to reimburse qualified medical expenses of former employees, or of their surviving spouses and dependents, with forfeiture only when all such persons were deceased.
Executive Compensation: April 2005 Developments
The SEC has extended the deadline by which companies must comply with the FASB’s Statement of Financial Accounting Standards 123R (revised in 2004) regarding share-based payments.
The new deadline generally allows companies to comply at the beginning of their next fiscal year. Prior to the extension, the deadline required a mid-year change for many calendar year companies.The new Bankruptcy Act includes restrictions on retention bonuses and severance pay for the benefit of insiders.
Under revised Section 503, if an employer files for bankruptcy, an insider may not be able to retain some or all of the insider’s retention bonus or severance pay. Retention bonuses paid to an insider must be found by the bankruptcy court to be essential to retention of the person because the individual has a bona fide job offer from another business at the same or higher rate of pay, that the individual’s services are essential to the business, and that the payment is within statutory guidelines as to amount. Severance pay paid to an insider must be found to be part of a broad-based severance pay program and the amount must be within statutory guidelines. Other payments outside the normal course of business and not justified by the facts and circumstances of the case, including transfers to or obligations incurred for the benefit of officers, managers, or consultants hired after the filing of the petition also will not be allowed. This provision applies to bankruptcy cases filed on or after April 20, 2005.IRS has recently issued new audit technique guidelines related to executive compensation and fringe benefit issues.
The guidelines relate to Code Section 162(m) (excessive employer remuneration), Code Section 280G (golden parachutes), stock based compensation, transfer of compensatory stock options to related persons, nonqualified deferred compensation, split dollar life insurance, and fringe benefits. The guidelines identify specific documents to be reviewed in an audit, questions to be asked, and document requests to be made, and include discussion of certain substantive rules. Review of the guidelines may provide useful insight when creating or modifying any of the type of covered benefits. The guidelines are found on the IRS website at:http://www.irs.gov/businesses/corporations/article/0,,id=134943,00.html.
Question And Answer Of The Month
Question: Just how long can we put off examining the impact of new Code Section 409A on our deferred compensation plans, severance pay plans, and other arrangements that may involve nonqualified deferred compensation?
Answer: There is a very serious and significant deadline approaching on December 31, 2005. Preliminary review of programs that may be affected by new Code Section 409A should be well underway now so that action may be taken as soon as the next round of guidance (expected in June) is available. Final plan designs and drafting should not occur until after the new guidance is issued, but if you have not yet started the process of identifying which plans are subject to the new rules, you should do so immediately.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
