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CCH® PAYROLL — 6/4/08

Military bill with payroll provisions cleared for President

Congress has passed H.R. 6081, the Heroes Earnings Assistance and Relief Tax (HEART) Act. The bill, which would extend and/or modify several benefit provisions for the military, contains a few payroll-related items.

Combat pay

The availability of the election to treat combat pay that is otherwise excluded from gross income under Code Sec. 112 as earned income for purposes of the earned income credit would be permanently extended, effective for taxable years beginning after December 31, 2007.

Differential pay

The definition of wages would be amended for purposes of the federal income tax withholding rules applicable to an employer's payment of wages. The employer's payment of any differential wage payment to the employee would be included in income. Differential wage payment would be defined as any payment which: (1) is made by an employer to an individual with respect to any period during which the individual is performing service in the uniformed services while on active duty for a period of more than 30 days; and (2) would represent all or a portion of the wages that the individual would have received from the employer if the individual were performing services for the employer.

Retirement plans. The provision would also provides rules relating to differential wage payments for purposes of a retirement plan that is subject to Code Sec. 414(u). Specifically, an individual receiving a differential wage payment would be required to be treated as an employee and the differential wage payment would be treated as compensation. In addition, a retirement plan that is subject to Code Sec. 414(u) would not be treated as failing to meet certain requirements relating to minimum participation and nondiscrimination standards by reason of any contribution or benefit that is based on the differential wage payment if all of the sponsoring employer's employees: (1) are entitled to differential wage payments on reasonably equivalent terms; and (2) if all employees eligible to participate in a retirement plan maintained by the employer are entitled to make contributions based on such differential payments on reasonably equivalent terms.

An individual would be treated as having been severed from employment during any period the individual is performing service in the uniformed services while on active duty for a period of more than 30 days for purposes of the limitation on in-service distributions with respect to: (1) elective deferrals under a Code Sec. 401(k) plan; (2) amounts attributable to a salary reduction agreement under a Code Sec. 403(b) tax-sheltered annuity; (3) amounts contributed to a custodial account described in section Code Sec. 403(b)(7); and (4) amounts deferred under an eligible deferred compensation plan (described in section Code Sec. 457(b)). Thus, such individuals would not be prohibited from receiving distributions on account of not severing employment. However, if any amounts are distributed on account of the foregoing rule, the individual would not be permitted to make elective deferrals or employee contributions to the plan during the six-month period beginning on the date of distribution.

IRAs. For purposes of the limitation on contributions to an IRA, the provision would amend the term “compensation” to include differential wage payments.

Plan amendment timing. A plan or annuity contract could be retroactively amended to comply with the provision, provided that the amendment is made no later than the last day of the first plan year beginning on or after January 1, 2010. Subject to certain conditions, a plan or annuity contract would be treated as being operated in accordance with its terms during the period prior to amendment and, except as provided by the Secretary of the Treasury, the plan or annuity contract does not fail to meet the requirements of the Code or the Employee Retirement Income Security Act of 1974 by reason of the amendment. The provision would be effective for withholding purposes on remuneration paid after December 31, 2008. Otherwise, the provision would be effective with respect to plan years beginning after December 31, 2008.

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