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CCH® PENSION — 10/05/09

New guidance on Code Sec. 457 issues seen

The IRS is planning to issue guidance on a number of issues involving Code Sec. 457 deferred compensation plans, officials from Treasury and the IRS indicated. In the meantime, the IRS is issuing private letter rulings and responses to congressional inquiries on hardship issues, grandfathered plans and other concerns, Cheryl Press, a senior attorney with the IRS Associate Chief Counsel (Tax Exempt and Government Entities), stated.

Press and Bill Bortz, Treasury associate benefits tax counsel, spoke at an American Law Institute-American Bar Association (ALI-ABA) conference on deferred compensation plans of tax-exempt and governmental employers. They were joined by Helen Morrison, Treasury acting deputy benefits tax counsel, and Michael Laing, a partner with Taft, Stettinius & Hollister LLP in Cincinnati. The panel was moderated by David Raish, a partner with Ropes & Gray LLP in Boston.

Press noted that the IRS has not issued major guidance under Code Sec. 457 since it released final regulations in 2003. She expects guidance on ineligible plans under Code Sec. 457(f); the definition of a governmental plan under Code Sec. 414(d); excess benefit plans under Code Sec. 415(d); and welfare benefit plans excluded from Code Sec. 457, such as bona fide sick and vacation leave, severance and death benefit plans.

Bortz said that the 2003 regulations focused on eligible Code Sec. 457(b) plans and provided less guidance on the exceptions to Code Sec. 457 and ineligible 457(f) plans. He further noted that various legislative changes that have yet to be addressed under Code Sec. 457, including the enactment of Code Sec. 409A deferred compensation requirements; new rules expanding eligible rollovers to nonspouse beneficiaries; and rollovers of payments under Code Sec. 402(l) for retiree medical benefits.

Notice 2007-62 requested comments on a number of Code Sec. 457 issues that need guidance, including the interaction of Code Secs. 409A and 457, the impact of the Code Sec. 409A definition of severance pay and the definition of a substantial risk of forfeiture for Code Sec. 457(f), Bortz said. Comments focused particularly on severance pay plans and whether the definition should incorporate elements of the 409A definition (benefits limited to twice final compensation; benefits conditioned on involuntary termination).

Covenants not to compete

Bortz expressed concern about 457 plans deferring benefits using covenants not to compete and rolling risks of forfeiture. While the issues involve specific facts and circumstances, Bortz said he does not think these clauses work. Press said she has never seen a good noncompete clause. A big problem is that employers do not monitor the actions of their former employees, so there is no enforcement, she stated. Laing queried whether the former employee could provide a representation or certification of compliance concerning noncompetition.

Corrections and audits

The government also is exploring relief for 457 plans maintained by agencies and instrumentalities that believed they were government employers (which must maintain funded plans) but turned out to be private exempt organizations, Press said. Correction of 457 plans is less of an issue for actual government employers, who have 180 days to correct their plans retroactively after notice from the IRS, she stated.

Press said that the IRS is conducting plan audits under Code Secs. 403(b) and 457. She expressed some concern about the treatment of amounts deferred until retirement as severance pay, ineligible plans under Code Sec. 457(f), and employees entitled to "buckets of benefits" with a default allocation to a 457(f) plan. While the IRS is less concerned about government plans, it will audit them if there is an interaction between Code Secs. 403(b) and 457.

Hardship distributions

The IRS is receiving a number of inquiries, such as letters from Congress, concerning 457 plan participants who have been denied a hardship distribution, Press stated. The IRS will not rule on whether the employee is entitled to a distribution for an unforeseeable emergency. "We don't administer Code Sec. 457 plans," Press declared. She said that plan administrators are very conservative since hardship distributions are an optional plan provision. The IRS changed the rules to allow distributions for circumstances affecting dependents, not just family members. The IRS intended for this to add flexibility, but administrators saw it as a tightening of the rules. So the IRS has instructed plan administrators to "loosen up a little bit," she said.

The IRS "wants to see good practices and procedures," a trail of information documenting the reason for the hardship distribution, Press told the conference. Emphasizing that a participant cannot "self-certify" a hardship, she noted that, on audit, the IRS looks for certification and back-up information.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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