Month: October 2008

Surprising results reported at the Tax Foundation here. Excerpt:

To the surprise of some, even though Senator Obama’s tax plan lowers taxes for the bottom four quintiles, marginal tax rates would fall only for the very lowest-income couples. Taking both income and payroll taxes into account, those at the very bottom of the income distribution would see their effective marginal tax rates fall from 27.4 percent to minus 58.6 percent due to proposed changes to the earned income tax credit and Senator Obama’s new “Making Work Pay” credit.

Most low- and moderate-income couples would see their effective marginal tax rates rise, in some cases, significantly. Indeed, some low- and moderate-income taxpayers will see their marginal rates rise to more than 50 percent.

High-income taxpayers can also expect their effective marginal tax rates to rise—to 47.2 percent-under Senator Obama’s tax plan. This increase is caused by rolling back the 2001 and 2003 reductions in the top two tax rates, curtailing deductions and exemptions at high income levels, and potentially raising Social Security taxes.

Senator McCain’s tax plan also changes marginal tax rates. His proposal to replace the exclusion for employer-based health insurance with a new health tax credit boosts taxpayers’ taxable incomes by their health insurance premiums which generally pushes taxpayers into higher tax brackets, but not to as great an extent as Senator Obama’s tax plan.

(It would be interesting to calculate how much overall tax a person would end up paying under the Obama plan considering the sum of the following: (1) federal tax owed under the highest income tax bracket, (2) state income tax, (3) local tax (which we pay here in the East), and (4) self-employment tax if you are self-employed. Also, add to that real estate taxes (also very high in the East) and sales tax.)

At the recent Hearing before the U.S. House Committee on Education and Labor, entitled “The Impact of the Financial Crisis on Workers’ Retirement Security,” there was a lot of discussion about the dire state of the retirement security of Americans. And from that hearing came the remark that American workers have lost as much as $2 trillion in retirement savings over the last year and that the system is broken. You can access the testimony here (as well as the recommended fixes). While it is true that we need to be examining a number of areas involved here, I don’t agree with those who are advocating that we need a universal pension system. I would say that there are ways to improve the current system and for starters would recommend the following:

(1) Congress should get rid of the oppressive excise tax (50%) imposed on surplus assets distributed to employers from overfunded defined benefit plans. This tax which was enacted in the 80’s was the beginning of the decline of the defined benefit plan (IMHO). One of the reasons this tax is so unfair is that there is no way employers can adequately predict exactly how much money should go in to a defined benefit plan, i.e. actuaries can only make an educated guess at what the market is going to do and the mortality rates are going to be. Therefore, in the 80’s there were a lot of plans that were overfunded. This enabled plans to ride out the down times in the market. However, now with this excise penalty tax in place, employers have been much more cautious about how much they put into these plans and therefore, when the plan hits rough times, many employers are forced to terminate or freeze them. Many such employers will then adopt a 401(k) plan in its place which unfortunately doesn’t always compare with the rich benefits people have or used to have under the defined benefit plan system. Thus, Congress should repeal the Section 4980 excise tax so as to encourage employers to maintain defined benefit plans and perhaps encourage employers who have abandoned these plans to reinstate them.

(2) Congress should get rid of the 10% penalty tax on early distributions. It is enough of a disincentive for people to have to pay income tax on a distribution. They do not need an additional tax like the early distribution penalty to encourage them to keep their money in a retirement plan socked away for retirement. In fact, I would argue that this tax actually discourages people from saving. Whether or not Congress does something on a permanent basis, they need to at least get rid of this tax on a temporary basis for people affected by this economic crisis.

(3) Congress should get rid of the minimum distribution requirements. Older Americans are lulled into thinking that because they are taking a distribution and paying tax on it, they can then spend it and do not have to save it. So, when the stock market declines, they do not have enough money in their retirement plan to make up the difference. It also forces older Americans to have to liquidate their assets to pay a distribution.

Also, dittos on all of the efforts to reduce fees and make them more transparent. See also these comments from Jerry Bramlett who testified at the Hearing:

. . . I do not believe the 401(k) system is doing an adequate job of educating participants as to how they need to invest their account as they get closer to retirement. The practical impact of a substantial market decline on a 64-year old worker months away from retirement can be very different than the impact on a 50-year old 15 years from retirement. If the retirement account of the 64-year old is heavily invested in equities, the impact of a major market decline on retirement income expectations can be devastating. However, if that same account had been properly diversified with a greater emphasis on fixed income securities, the impact of a major market decline may very well be manageable. Although the advent of target-date investment funds based on a participant’s age has greatly helped in this regard we need to do more. I would recommend that Congress instruct the Department of Labor to develop educational materials specifically for 401(k) participants that have reached age 50 to assist them in better managing their account in preparation for retirement.

UPDATE: Apparently, McCain is advocating the repeal of the minimum distribution requirements as well. Read about it here- “McCain Calls for Suspending Rule on Retirement Accounts.” The article notes that “[s]uspending that part of the tax code would benefit

Press release is here:

Statutory Exemption for Cross-Trading of Securities

Selection of Annuity Providers–Safe Harbor for Individual Account Plans

Amendment to Interpretive Bulletin 95-1

Amendments to Safe Harbor for Distributions From Terminated Individual Account Plans and Termination of Abandoned Individual Account Plans To Require Inherited Individual Retirement Plans for Missing Nonspouse Beneficiaries

Adoption of Amendment to Prohibited Transaction Exemption 2006- 06; (PTE 2006-06) For Services Provided in Connection With the Termination of Abandoned Individual Account Plans

Regarding the final regulation pertaining to the selection of annuity providers for individual account plans (a hot topic right now due to AIG’s demise and bailout):

(1) The DOL has eliminated paragraph (c)(2) of the proposed regulation which provided additional guidance concerning what information a fiduciary should consider in meeting the requirements for the safe harbor. One of those factors was “[t]he annuity provider’s ratings by insurance ratings services.” However, the DOL states in the preamble to the final regulations:

Further, although an annuity provider’s ratings by insurance ratings services are not part of the final safe harbor, in many instances, fiduciaries may want to consider them, particularly if the ratings raise questions regarding the provider’s ability to make future payments under the annuity contract. The Department also believes that some information regarding additional protections that might be available through a state guaranty association for an annuity provider also would be useful information to a plan fiduciary, even if limited to that information which is generally available to the public and easily accessible through such associations, state insurance departments, or elsewhere.

(2) In addition, the DOL makes it clear that a fiduciary is not home free by meeting the safe harbor at the time the annuity provider is selected as a provider for the plan generally. The fiduciary has ongoing responsibilities of monitoring the provider to ensure the ability of the annuity provider to make all future payments under the annuity contract and that the costs (including fees and commissions) of the annuity contract are still appropriate. The fiduciary is required to consult an expert, if necessary.

When employees terminate employment or retire, some plans are written to allow former employees the flexibility of keeping their plan monies in their former employer’s plan. Employers are asking whether such flexibility is desirable from an employer’s standpoint. Yes, according to this article: Is Your Defined-Contribution Plan Leaking? No, according to one advisor as reported in this article: Advisers to make funds transparent to avoid suits.

However, something not really discussed in either article is the fact that the DOL now permits employers to allocate the administrative expenses associated with these former employee accounts to such accounts (i.e. active participants need not share in the expenses associated with these accounts). However, if employers want to take advantage of this rule, their plan documents will have to be amended accordingly. In addition, employers should make sure that the Summary Plan Description and any communication documents sent to participants and former participants are updated to reflect the use of the rule.

Excerpt from the DOL’s Field Assistance Bulletin 2003-3 which addresses this practice:

Some plans, with respect to which the plan sponsor generally pays the administrative expenses of the plan, provide for the assessment of administrative expenses against participants who have separated from employment. In general, it is permissible to charge the reasonable expenses of administering a plan to the individual accounts of the plan’s participants and beneficiaries. Nothing in Title I of ERISA limits the ability of a plan sponsor to pay only certain plan expenses or only expenses on behalf of certain plan participants. In the latter case, such payments by a plan sponsor on behalf of certain plan participants are equivalent to the plan sponsor providing an increased benefit to those employees on whose behalf the expenses are paid. Therefore, plans may charge vested separated participant accounts the account’s share (e.g., pro rata or per capita) of reasonable plan expenses, without regard to whether the accounts of active participants are charged such expenses and without regard to whether the vested separated participant was afforded the option of withdrawing the funds from his or her account or the option to roll the funds over to another plan or individual retirement account.

Something to consider. . .

Sutherland reports here on the opinion issued in the Caterpillar case last week and notes that it is the eleventh ERISA revenue-sharing case that a district court has declined to dismiss on the pleadings.

Very interesting paper from the University of Chicago: The Intergenerational Transfer of Public Pension Promises. Abstract:

The value of pension promises already made by US state governments will grow to approximately $7.9 trillion in 15 years. We study investment strategies of state pension plans and estimate the distribution of future funding outcomes. We conservatively predict a 50% chance of aggregate underfunding greater than $750 billion and a 25% chance of at least $1.75 trillion (in 2005 dollars). Adjusting for risk, the true intergenerational transfer is substantially larger. Insuring both taxpayers against funding deficits and plan participants against benefit reductions would cost almost $2 trillion today, even though governments portray state pensions as almost fully funded.

From the Wall Street Journal:

The Internal Revenue Service significantly relaxed the rules governing how U.S. corporations can repatriate cash parked overseas, in yet another government move to ease the credit crisis.

The ruling, issued late Friday, allows companies to bring back money for months at a time without incurring the 35% corporate income tax they normally would owe.

More from the New York Times here.

From Bloomberg: U.S. Eases Tax Rule to Open Offshore Cash `Spigots’

See Notice 2008-91 for more info.

AutoBlogGreen has some info about the credits here.

Instapundit asks: Do you get a credit if you do your own conversion to plug-in?

Joe Kristan has a good post on “How the refundable AMT credit works” in an example involving incentive stock options here. He discusses the dangers of ISOs and AMT in a volatile market:

The bottom line? Our reader has to do some thinking on whether the savings of having capital gain treatment of ISOs is worth both the market risk on his stock and the high possibility of having to wait until 2012 to recover taxes due in 2008 if he retains ISO treatment. If the stock goes to zero before he sells it, he has a $420,000 AMT liability and no cash.

(1) Executive Compensation Limitations for Troubled Asset Relief Program (“TARP”) Participants:

Direct Purchases—Where the Secretary determines that the purposes of the Act are best met through direct purchases from an individual financial institution where no bidding process or market prices are available and the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction, the Secretary shall require that the financial institution meet appropriate standards for executive compensation and corporate governance. The standards under this section shall be effective for the duration of the holding by the Secretary of the equity position.

Criteria for Standards:

1. General rule: Limits on compensation to exclude incentives for executive officers to take unnecessary and excessive risks that threaten franchise value during such participation.

2. Clawback: A provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains , or other criteria that are later proven to be materially inaccurate; and

3. Golden parachute: A prohibition on the financial institution making golden parachute payment to its senior executive officers.

For participants in TARP auctions who sell $300 million in assets, or whose combined assistance from direct purchases and auctions reaches $300 million, there will be limits on golden parachutes and the tax deductibility of executive compensation:

1. Limits on tax deductions. Executive compensation in excess of $500,000 is not deductible, and the definition of executive compensation is expanded to include performance pay and stock options.

2. Golden parachutes tax penalties. Current golden parachute tax regime are expanded to apply to existing employee contracts—a 20% excise tax applies to parachute payments a (normal 3 times salary rule) triggered by termination other than by retirement of the employee, including involuntary termination of the employee, change in control or bankruptcy of the company. The employer would lose the corresponding deduction on the parachute payment.

3. Golden parachutes prohibition. Golden parachutes will be prohibited prospectively for the top 5 executives in the case of termination, or in the case of bankruptcy, insolvency, or receivorship of the financial institution

(2) Extension and Modification of AMT Credit Allowance Against Incentive Stock Options (ISOs):

Many companies offer ISOs as compensation. Under the regular tax, ISOs are not taxed upon exercise. Under the AMT, however, a taxpayer must pay tax on the stock value when the option is exercised. The economic downturn in 2000 resulted in many individuals having to pay tax on “phantom income” because the stock prices dropped dramatically since the date of exercise. In 2006, Congress provided relief for these situations, but additional relief is needed to correct this problem. Under current law, an individual is allowed a refundable AMT credit amount that is the greater of (1) the lesser of $5,000 or the unused AMT credit amount or (2) 20 percent of the unused AMT tax credit. The AMT credit amount is reduced for those with adjusted gross income (AGI) above $150,000 (joint filers) and $100,000 (single filers). The bill allows 50% of long-term unused minimum tax credits to be refunded over each of two years instead of 20% over each of five years, eliminate the income phase-out, and abates any underpayment of tax outstanding on the date of enactment related to ISOs and the AMT including interest.

(3) IRA Rollover Provision:

The Pension Protection Act of 2006 (PPA) created a provision allowing taxpayers to make tax-free contributions from their IRA plans to qualified charitable organizations. This tax benefit expired on December 31, 2007. The bill would extend the provision through 2009. The bill is effective for distributions after December 31, 2007.

(4) Easing of Loan Limits for Qualified Plans in Midwestern Disaster Area:

The bill effectively doubles the limitation on loans from a 401(k), 403(b), or a governmental 457(b) plan by allowing participants located in a Midwestern disaster area and who sustained economic loss by reason of the tornadoes and floods giving rise to the designation of the area as a disaster area to receive loans up to the lesser of $100,000, or 100 percent of the vested accrued benefit for loans made after the date of enactment and before January 1, 2010. In addition, outstanding loan payments due on or after the applicable declaration date and before January 1, 2010 may be deferred an additional 12 months, with appropriate adjustments for interest.

(5) Current Inclusion of Deferred Compensation Paid by Certain Tax Indifferent Parties under new Section 457A:

Section 457A would impose significant restrictions on techniques commonly used by managers of offshore hedge funds to defer fee income. The restrictions would generally apply to deferred compensation attributable to services rendered after 2008. Read about the provision in this Akin Gump Tax Alert.

(6) Mental Health Parity Provisions:

The bill does not mandate group health plans to provide mental health coverage. However, if a plan does offer mental health coverage, then, it requires:

Equity in financial requirements, such as deductibles, co-payments, coinsurance, and out-of-pocket expenses.

Equity in treatment limits, such as caps on the frequency or number of visits, limits on days of coverage, or other similar limits on the scope and duration of treatment.

Equality in out-of-network coverage.

Effective Date: The provisions apply to group health plans for plan years beginning after the date that is 1 year after the date of enactment regardless of whether regulations have been issued to carry out the amendments by the effective date (except that the amendments made by subsections (a)(5), (b)(5), and (c)(5) of the Act relating to striking of certain sunset provisions are to take effect on January 1, 2009).

Some comments on the bill here and here.