| September 2006 |
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TaxAdvisor
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Pension Protection Act of 2006
The recently passed Pension Protection Act of 2006 is a massive tax bill that
overhauls the funding and disclosure rules for defined benefit plans, addresses
conversions of pension plans to cash balance plans, carries liberalized payout
and rollover rules, and makes a host of other changes relating to pension plans
and their beneficiaries. Here's an overview of the key tax changes in this
important new legislation:
Reform of the single-employer defined benefit rules
For single-employer defined benefit plans, the Act:
- Requires employers to make contributions to their single-employer defined
benefit pension plans over the next seven years in order to make those plans
100% funded. Formerly, a 90% funding level was acceptable.
- Specifies that the discount rate used to calculate the present value of
current pension liabilities be based on a segment yield curve of corporate
bonds.
- Triggers accelerated contributions for "at-risk" plans.
- Reduces the smoothing of interest rates to two years (instead of five for
assets and four for liabilities under current law).
- Permits employers to make additional maximum deductible contributions.
- Prohibits further benefit accruals for lump-sum distributions or shut-down
benefits from plans funded at less than 60%.
- Restricts the use of deferred executive compensation arrangements for
employers with severely underfunded plans.
- Permanently establishes an employer-paid termination premium of $1,250 per
participant if a plan sponsor terminates its employee pension plan upon
entering bankruptcy
- Establishes special rules for airlines.
Reform of the multiemployer pension system
The Act's changes relating to multiemployer plans include:
- Identifying underfunded multiemployer pension plans and establishing
quantifiable benchmarks for measuring a plan's funding improvement.
- Providing new notice requirements for underfunded plans.
- Changing the amortization schedule for any plan benefit amendments from 30
years to 15 years.
- Increasing the maximum deductible limit to 140% of current liability.
- Requiring plans trustees to improve the health of the plan by one-third
within 10 years if a plan is less than 80% funded or will hit a funding
deficiency within seven years.
- Prohibiting benefit increases if the increase causes the plan to fall
below 65% funded status.
New disclosure rules for qualified plans
One of the overarching themes of the Act is that there should be more pension
transparency so that workers, regulators and investors can better keep tabs on
the financial health of traditional pension plans. To meet this need, the Act:
- Requires both single and multiemployer plans to include more detailed and
specific information on their Form 5500 filings.
- Enhances Form 4010 disclosure requirements and makes all Form 4010
information filed with PBGC available to the public, save for sensitive
corporate proprietary information.
- Establishes an 80%, at-risk threshold that determines whether plans pose a
threat to PBCG and therefore must file Form 4010 information.
- Requires both single and multiemployer pension plans to notify workers and
retirees of the funded status of their plan with 120 days after the close of
the plan year.
- Prohibit companies from forcing employees to invest any of their own
retirement savings contributions in the stock of the employer.
- Makes it clear that companies have fiduciary responsibility for workers'
savings during "blackout" periods, when workers are temporarily barred from
making changes to their 401(k) investments.
- Requires companies to give workers quarterly benefit statements that
include information about accounts, including the value of their assets, their
rights to diversify, and the importance of maintaining a diversified
portfolio.
New investment advice rules
The Act:
- Permits qualified "fiduciary advisers" to offer investment advice to help
employees manage their 401(k) and other retirement options.
- Puts in place fiduciary and disclosure safeguards to ensure that advice
provided to employees is solely in their best interest.
- Requires fiduciary advisers for employer-sponsored plans to base their
recommendations on a computer model that is certified and audited by an
independent party.
- Requires fiduciary advisers for non-employer sponsored plans to charge a
flat rate fee for one year (with no computer model).
Liberalized plan payout and rollover rules
Provisions in the Act that liberalize plan payout and rollover rules include
the following:
- After 2007, taxpayers will be permitted to make direct rollovers from
qualified plans to Roth IRAs.
- For purposes of the 401(k) hardship distribution rules, "hardship"
includes hardship of a beneficiary under the plan (even if the beneficiary is
not a spouse or dependent). This provision is effective on August 17, 2006.
- Members of the National Guard and Reserves called to active duty through
2007 can make penalty-free withdrawals from retirement plans. Withdrawn
amounts may be repaid to the IRA or pension plan within two years of the
distribution.
- The 10% early withdrawal penalty for distributions to public safety
employees over age 50 (including police, fire, and emergency medical services)
who may retire early is waived.
- Effective for post-2006 distributions, nonspouse designated beneficiaries
are allowed to make rollovers of inherited amounts in qualified plans,
governmental Section 457 plans, or tax-sheltered annuities to their own IRAs
(treated as inherited IRAs).
- Effective for distributions in plan years beginning after 2006, defined
benefits plans can make in-service distributions to age-62-or-older
participants.
Retirement savings provisions made permanent
The Act makes permanent a number of retirement plan and IRA liberalizations
that were added to the tax laws in 2001 but were set to sunset after 2010. By
making the 2001 changes permanent, the new law preserves the advantages of
higher employee contribution limits for employer plans, higher IRA contribution
limits, more flexible plan rules, portability, a catch-up for those over 50, and
an increase in employer contribution limits. The new law also makes permanent
the saver's credit, which would not have been available after 2006 absent the
extension.
Charitable reforms
The Act also contains a package of provisions to help prevent abuse in the
charitable sector and provide additional tax incentives for Americans to give
more resources to the charitable community. The incentives include:
- Tax -free distributions from IRAs for charitable purposes.
Taxpayers can exclude from gross income certain distributions of up to
$100,000 from a traditional or Roth IRA if made to a tax-exempt organization
to which deductible contributions can be made. The provision is effective for
two years through 2007.
- Charitable deduction for contributions of food inventory. An
enhanced deduction for donations of food inventory which was formerly
available on to C corporations is extended to all trades and businesses,
effective for two years through 2007.
- Basis adjustment to stock of S corporation contributing property.
If an S corporation contributes property to a charity, an S corporation
shareholder only has to reduce his basis in stock of the S corporation by his
pro rata share of the adjusted basis of the contributed property, rather than
by the amount of the charitable contribution that flows through to him. The
provision is effective for two years through 2007.
- Charitable deduction for contributions of book inventory. The
current-law provision that adds public schools to the list of eligible donees
for the enhanced deduction for contributions of qualified book inventory by C
corporations is extended for two years through 2007.
- Qualified conservation contributions. The new law raises the
charitable deduction limit-from 30% of adjusted gross income (AGI) to 50%--for
qualified conservation contributions, as long as it does not prevent the use
of the donated land for farming or ranching purposes. The charitable deduction
limit is raised to 100% of AGI for eligible farmers and ranchers. Unused
contributions can be carried forward for up to 15 years. The provision is
effective for two years through 2007.
On the charitable reform side, the new rules:
- Require reports to the Treasury Department on certain life insurance
contracts.
- Double the fines and penalties applicable to certain activities by
charities, social welfare organizations, private foundations and exempt
organization managers.
- Clarify the terms of facade easements in historic districts, and also
clarify that the charitable deduction is reduced if a rehabilitation tax
credit has been claimed with respect to the donated property.
- Limit the basis for donated taxidermy property and provide that the value
of the deduction is equal to the lesser of basis or fair market value.
- Require the recapture of any tax benefit derived from the contribution of
property with respect to which a fair market value deduction was claimed if
the property is not used for an exempt purpose of the donee organization,
effective for contributions made after September 1, 2006.
- Generally prohibit deductions for contributions of clothing and household
items unless they are in good used condition or better.
- Require that in the case of a charitable contribution of money, regardless
of the amount, the donor must maintain a cancelled check, bank record or
receipt from the donee organization showing the name of the donee
organization, the date of the contribution, and the amount of the
contribution. This is effective for contributions made in tax years beginning
after August 17, 2006.
- Lower the threshold for imposing accuracy-related penalties on a taxpayer
who claims a deduction for donated property for which a qualified appraisal is
required.
- Impose certain requirements on tax-exempt organizations that offer credit
counseling services.
- Apply an excess benefits transaction tax on any grant, loan, compensation
or other similar payments from a donor-advised fund to a person that with
respect to such fund is a donor, donor adviser, or a related person, and from
a supporting organization to a substantial contributor or a related person.
- Require that unrelated business income tax returns of 501(c)(3)
organizations be made publicly available.
Please keep in mind that I've described only the highlights of the most
important changes in the new law. Please call me at your earliest convenience if
you need more details on how you may be affected by this important tax
legislation.
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