Recently in Employee Benefits Category

August 20, 2015

Employee Benefits-IRS Summarizes How the Health Care Law Affects Aggregated Companies

In IRS Health Care Tax Tip 2015-50, August 18, 2015, the Internal Revenue Service (the "IRS") summarizes how the health care law affects aggregated companies. Here is what the IRS said.

The Affordable Care Act applies an approach to common ownership that also applies for other tax and employee benefit purposes. This longstanding rule generally treats companies that have a common owner or similar relationship as a single employer. These are aggregated companies. The law combines these companies to determine whether they employ at least 50 full-time employees including full-time equivalents.

If the combined employee total meets the threshold, then each separate company is an applicable large employer. Each company - even those that do not individually meet the threshold - is subject to the employer shared responsibility provisions.

These rules for combining related employers do not determine whether a particular company owes an employer shared responsibility payment or the amount of any payment. The IRS will determine payments separately for each company.

For more information about how the employer shared responsibility provisions may affect your company, see our Questions and Answers on IRS.gov/aca. For details about how to determine if you are an applicable large employer, including the aggregation rules, see Determining If You Are an Applicable Large Employer.

August 19, 2015

Employee Benefits-IRS Summarizes What Employers Need to Know about the Affordable Care Act


In IRS Health Care Tax Tip 2015-46, August 4, 2015, the Internal Revenue Service (the "IRS") summarizes what employers need to know about the Affordable Care Act (the "ACA"). Here is what the IRS said.

The health care law contains tax provisions that affect employers. The size and structure of a workforce - small or large - helps determine which parts of the law apply to which employers. Calculating the number of employees is especially important for employers that have close to 50 employees or whose work force fluctuates during the year.

The number of employees an employer has during the current year determines whether it is an applicable large employer for the following year. Applicable large employers are generally those with 50 or more full-time employees or full-time equivalent employees. Under the employer shared responsibility provision, ALEs are required to offer their full-time employees and dependents affordable coverage that provides minimum value. Employers with fewer than 50 full-time or full-time equivalent employees are not applicable large employers.

The Tax Tip then sets forth a chart which summarizes ACA requirements for employers, and says that, to find more information on these and other ACA tax provisions, visit IRS.gov/aca.

August 12, 2015

Employee Benefits-The Penalties For Failure To File Or Provide An ACA Information Return Or Statement Has At Least Doubled

The recently enacted Trade Preferences Extension Act of 2015 (the "Act") doubles the penalties for the failure to file or provide ACA information returns and statements.

Returns And Statements Required. The Affordable Care Act (the "ACA") added section 6056 to the Internal Revenue Code (the "Code"). Under that section, an "Applicable Large Employer" or "ALE" which maintains a group health plan is required to file an information return relating to the plan with the IRS. This return provides information on the health coverage provided under the plan. The ALE must generally use Form 1095-C, with transmittal Form 1094-C, as the return. The filing is due by the February 28 (March 31 if filing is electronic) following the year for which the return is made. In addition, the ALE is required to furnish each full-time employee with a statement that includes the same information provided to the IRS on the information return, by January 31 following the year to which the statement relates.

Further, the ACA added section 6055 to the Code. Under that section, the plan sponsor of a self-insured group health plan (including the trustees of a multiemployer health plan) is required to file an information return relating to the plan with the IRS. This return provides information on the "minimum essential coverage" provided under the plan. The plan sponsor must generally use Form 1095-B, with transmittal Form 1094-B, as the return. The filing is due by the February 28 (March 31 if filing is electronic) following the year for which the return is made. The plan sponsor is required to furnish, to each covered individual of the plan, a statement that includes the same information provided to the IRS on the information return, by January 31 following the year to which the statement relates.

If the plan sponsor which maintains a self-insured plan is also an ALE, then the plan sponsor must combine reporting under sections 6055 and 6056, by filing a single information return, Form 1095-C and transmittal, Form 1094-C. Then a single statement would be given to each full-time employee and other covered individuals.
The first returns and statements are for calendar year 2015, and are therefore due in 2016.

Information Reporting Penalties. An ALE, or plan sponsor maintaining a self-insured group health plan, which fails to comply with the information reporting requirements described above may be subject to the general reporting penalty provisions under section 6721 (failure to file correct information returns) and section 6722 (failure to furnish correct payee statement) of the Code. And the Act has at least doubled to the applicable penalties under those sections. As such, the penalties are as follows:

• For returns required to be filed after 2015, the penalty for failure to file an information return is increased from $100 to $250 for each return for which such failure occurs, with a total penalty for any calendar year capped at $3,000,000 (up from the $1,500,000 total for pre-2015 returns).

• For statements due after 2015, the penalty for failure to provide a correct statement to a full-time employee or other covered individual is increased from $100 to $250 for each statement for which such failure occurs, with the total penalty for a calendar year capped at $3,000,000 (up from the $1,500,000 total for pre-2015 statements).

• Special rules apply that increase the per-statement and total penalties if there is intentional disregard of the requirement to furnish a payee statement.

Note that the waiver of penalty and special rules under section 6724 of the Code, and the applicable regulations, including abatement of information return penalties for reasonable cause, may apply to certain failures under section 6721 or 6722.

August 11, 2015

Employee Benefits-IRS Discusses The Tax Treatment Of Contributions Made To An HRA Established For Retirees

In Private Letter Ruling Number 201528004, the IRS faced the following situation, and came to the following conclusions:

The taxpayer currently provides health coverage to eligible retirees, their spouses, their registered domestic partners and their dependents through a choice of health plans. Upon retirement, eligible retirees generally pay premiums for the health coverage with their own after-tax funds. Some retirees are also eligible to have a portion of their accumulated unused sick leave at retirement mandatorily converted to a contribution from the employer to pay for the health insurance premiums. Contributions are uniform and based on hours of sick leave available for conversion and the class of retiree coverage (e.g., retiree-only coverage, retiree-plus-dependent, retiree-plus-family).

The taxpayer proposes to establish a new retiree medical benefit structure in the form of a health reimbursement arrangement for the benefit of eligible retirees, their spouses, their registered domestic partners and their dependents (the "retiree HRA"). Eligible employees hired before a certain date will make an election at retirement to participate in either: (1) existing health plans with premiums funded, in part, by mandatory sick leave conversion, or (2) the retiree HRA funded by mandatory conversion of accumulated unused sick leave at retirement. Retiree HRA contributions are uniform and based on hours of sick leave available for conversion, class of retiree coverage, and Medicare eligibility. The election to waive coverage under the existing health plans may not generally be changed. No other contributions, other than the sick leave conversion, are made to the retiree HRA. The taxpayer represents that amounts in the retiree HRA may be used only to reimburse health insurance premiums and medical expenses as defined in section 213 of the Code. The retiree HRA will not pay claims for registered domestic partner's medical expenses. Nor will the retiree HRA reimburse spouse's group health insurance that has been paid with pre-tax dollars. The taxpayer represents that under no circumstance may the eligible retiree or any beneficiary receive any conversion amounts at any time in cash or other benefits. Following the retiree's death, unused amounts continue for the benefit of the retiree's spouse, registered domestic partner and eligible dependents (children under 26).

Based on the foregoing, the IRS concludes that:

(1) Taxpayer contributions made to the retiree HRA on behalf of eligible retirees, spouses, and eligible dependents, which are used exclusively to pay for eligible medical expenses, are excludable from the gross income of eligible retirees under section 106 of the Code;

(2) Taxpayer contributions described in (1) are not "wages" and are not subject to FICA taxes under section 3121(a), FUTA taxes under section 3306(b) or income tax withholding under section 3401(a); and

(3) Taxpayer contributions made to the retiree HRA that are used to provide medical coverage for registered domestic partners of eligible retirees (e.g., health insurance premiums) are included in the gross income of eligible retirees under section 61 of the Code.

August 6, 2015

Employee Benefits-IRS Says That Small Business Can Get IRS Penalty Relief For Unfiled Retirement Plan Returns

In Employee Plans News, Issue No. 2015-8, July 27, 2015, the Internal Revenue Services (the "IRS") discussed how a small business can get relief from penalties for the failure to file retirement plan returns. Here is what the IRS said.

In IR-2015-96, July 14, 2015, the IRS encourages eligible small businesses that did not file certain retirement plan returns to take advantage of a low-cost penalty relief program enabling them to quickly come back into compliance. The program is designed to help small businesses that may have been unaware of the reporting requirements that apply to their retirement plans.

Small businesses that fail to file required annual retirement plan returns, usually Form 5500-EZ, can face stiff penalties -- up to $15,000 per return. However, by filing late returns under this program, eligible filers can avoid these penalties by paying only $500 for each return submitted, up to a maximum of $1,500 per plan. For that reason, program applicants are encouraged to include multiple late returns in a single submission. Find the details on how to participate in this program, under Revenue Procedure 2015-32, on IRS.gov.

The program is generally open to small businesses with plans covering a 100 percent owner or the partners in a business partnership, and the owner's or partner's spouse (but no other participants), and certain foreign plans. Those who have already been assessed a penalty for late filings are not eligible. The Department of Labor offers a similar relief program for businesses with retirement plans that include employees known as the Delinquent Filer Voluntary Compliance Program.

Started as a one-year pilot, the IRS program was made permanent in May 2015. The IRS has received about 12,000 late returns since the pilot program began in June 2014.
The IRS reminds retirement plan sponsors and administrators that in most cases, a return must be filed each year for the plan by the end of the seventh month following the close of the plan year. For plans that operate on a calendar-year basis, as most do, this means the 2014 return is due on July 31, 2015. For details, visit the Form 5500 Corner on IRS.gov.

July 29, 2015

Employee Benefits-IRS Announces That It Will No Longer Permit Use Of Lump Sums To Replace Life Income From A Defined Benefit Plan

In Notice 2015-49, the Internal Revenue Service (the "IRS") announced that the Treasury Department and the IRS intend to amend the required minimum distribution regulations under § 401(a)(9) of the Internal Revenue Code to address the use of lump sum payments to replace annuity payments being paid by a qualified defined benefit pension plan. The IRS said the the regulations, as amended, will provide that qualified defined benefit plans generally are not permitted to replace any joint and survivor, single life, or other annuity currently being paid with a lump sum payment or other accelerated form of distribution. The Treasury Department and the IRS intend that these amendments to the regulations will apply as of July 9, 2015, except with respect to certain accelerations of annuity payments described in the Notice.

July 24, 2015

Employee Benefits-IRS Discusses A Mid-Year Retirement Savings Check-Up For Workers

In IRS Retirement News for Employers, July 6, 2015 Edition, the Internal Revenue Service (the "IRS") advises workers to do a mid-year check up on their retirement savings. Here is what the IRS says.

Are you saving enough to afford the lifestyle you want when you retire? Now is a good time to check whether you're taking full advantage of all your retirement savings opportunities, while you still have the rest of the year to adjust your contribution levels.

Employer-sponsored retirement plans

Join the plan - If you haven't already, join your employer's retirement plan as soon as you can to increase your retirement savings. Many retirement plans have quarterly or semi-annual entry dates. Contact your employer to find out when you can start participating in the plan, and then join on the next entry date.

Make salary deferral contributions - If your employer's plan allows you to contribute, remember that you can decrease your taxable income by making pre-tax salary deferral contributions. You may also qualify for the Saver's Credit for contributing to your plan. Many plans allow salary deferral elections to be submitted at any time, so review your contribution rate to ensure you are contributing as much as the plan allows.
The maximum annual salary deferral contributions allowed for 2015 are:

• $18,000 to 401(k) or 403(b) plans
• $12,500 to SIMPLE plans

If you're age 50 or older by the end of the year, your plan may allow you to make additional catch-up contributions of:

• $6,000 to 401(k) or 403(b) plans
• $3,000 to SIMPLE plans

Your employer may match some of your salary deferral contributions. For example, your employer might contribute 50 cents for each dollar that you contribute to the plan from your salary up to a certain amount. Contact your plan administrator for details and adjust your salary deferrals to take full advantage of matching contributions.

Individual Retirement Arrangements (IRAs)

For 2015, the maximum total contributions you can make to all of your traditional and Roth IRAs is:

• $5,500 ($6,500 if you are age 50 or older), or
• your taxable compensation for the year, if your compensation was less than this dollar limit.

Some factors may limit or eliminate your ability to contribute to an Roth IRA or claim a deduction for your traditional IRA contribution (for example, your age, modified adjusted gross income, filing status and amount of compensation). See IRA Contribution Limits. The amount of traditional IRA contributions that you can deduct from your taxable income depends on whether you or your spouse were covered for any part of the year by an employer retirement plan if your income is above certain thresholds.

Remember, saving for retirement requires planning! That is why you should periodically review your retirement savings goals, savings options and annual contributions to maximize your retirement savings.

July 22, 2015

Employee Benefits-IRS Announces Revisions To The Employee Plans Determination Letter Program

In Announcement 2015-19, the Internal Revenue Service (the "IRS") describes important changes to the Employee Plans determination letter program for qualified retirement plans. Here is what the Announcement says.

Effective January 1, 2017, the IRS will eliminate the staggered 5-year determination letter remedial amendment cycles for individually designed plans. The IRS will limit the scope of the determination letter program for individually designed plans to initial plan qualification and qualification upon plan termination, and to certain other limited circumstances that will be determined by Treasury and the IRS.

As of January 1, 2017, the IRS will no longer accept determination letter applications based on the 5-year remedial amendment cycles. However, sponsors of Cycle A plans, described in section 9.03 of Rev. Proc. 2007-44, will continue to be permitted to submit determination letter applications during the period beginning February 1, 2016, and ending January 31, 2017.

Section 5.03 of Rev. Proc. 2007-44 extends the remedial amendment period for disqualifying provisions described in section 5.03(1) and (2) to the end of a plan's applicable remedial amendment cycle. As a result of the elimination of the 5-year remedial amendment cycles, the extension of the remedial amendment period provided in section 5.03 will not be available after December 31, 2016, and the remedial amendment period definition in § 1.401(b)-1 will apply. However, the Commissioner intends to extend the remedial amendment period for individually designed plans to a date that is expected to end no earlier than December 31, 2017.

The IRS is requesting comments on specific issues relating to the implementation of these changes to the determination letter program, and as to the situations in which an application for a determination letter will be accepted. The foregoing changes will be reflected in an update to Rev. Proc. 2007-44, and in a successor to Rev. Proc. 2015-6.

In addition, the IRS will no longer accept determination letter applications that are submitted off-cycle, except in limited circumstances. In connection with the modifications to the determination letter program described in this Announcement, the Treasury Department and the IRS are considering ways to make it easier for plan sponsors to comply with the qualified plan document require

July 15, 2015

Employee Benefits-District Court Rules That Benefits Under A Retiree-Only Health Plan Are Not Subject To The Lifetime Limit Under The Affordable Care Act.

In King v. Blue Cross and Blue Shield of Illinois, Case No.: 3:13-CV-1254-CAB-JMA (S.D. Cal. 2015), the court held that the benefits payable under a self-insured health care plan, which covers only retirees, are not subject to the lifetime limit on essential health benefits under the Affordable Care Act. How did the district court reach this conclusion?

The court said that the issue in this case involves an understanding of the interplay between the Public Health Service Act ("PHSA"), ERISA, and the Affordable Care Act. The court noted that, among its many other provisions, the Affordable Care Act amended the PHSA to ban lifetime limits on the dollar value of benefits for any group health participant or beneficiary. 42 U.S.C. § 300gg-11(a)(1). At the same time, the Affordable Care Act added a provision to ERISA stating that the requirements of the PHSA (as amended by the PPACA), which includes the lifetime limit ban, shall apply to group health plans. ERISA § 715(a)(1). However, Section 732 of ERISA, which pre-dates the Affordable Care Act, generally states that the requirements of this part (which includes § 715(a)(1)) does not apply to any group health plan for any plan year if, on the first day of such plan year, such plan has less than 2 participants who are current employees (the "Retiree Plan Exception").

The court reviewed and discussed the interaction among these and other provisions of the acts in question. The court concluded, and therefore ruled, that the Retiree Plan Exception exempts employer plans covering only retirees (and therefore fewer than two participants who are current employees) from the coverage mandates of the Affordable Care Act, including the amendments thereto by the Affordable Care Act such as the lifetime limit on essential health benefits.

July 9, 2015

Employee Benefits-District Court Rules That Employer Failed To Provide Former Employee With Sufficient Notice Of COBRA Rights

In Griffin v. Neptune Technology Group, Civil Action No. 2:14cv16-MHT (WO) (M.D. Alabama 2015), plaintiff Joshua Griffin sued his former employer, Neptune Technology Group, claiming, among other things, that Neptune illegally failed to provide appropriate notice that he could continue his health-insurance coverage under COBRA after his termination of employment at Neptune, and seeking statutory damages for this failure.

Griffin's primary complaint is that the contents of the notice Neptune uses were insufficient under the law to allow him to make an informed and intelligent decision whether to elect continued coverage under COBRA. The court noted that the regulations, at 29 C.F.R. § 2590.606-4, sets forth detailed requirements for the content of COBRA notices. It provides that the notice "shall be written in a manner calculated to be understood by the average plan participant and shall contain the following information," and then lists 14 different categories of information that must be included.

The court further noted that the notice actually given to Griffin tracks the requirements of § 2590.606-4 in several respects. The notice gave him the deadline for returning the notice, the premium amounts for himself and his spouse or dependents, and the date by which the premium needed to be paid. However, it does not contain most of the items required by the regulation. Out of the 14 categories in 29 C.F.R. § 2590.606-4, the notice completely omits nine. In addition, subsection (b)(v) requires inclusion of "[a]n explanation of the plan's procedures for electing continuation coverage, including an explanation of the time period during which the election must be made, and the date by which the election must be made." While Neptune's notice tells the reader that the election form must be returned within 60 days of the date of the letter and instructs the reader to "follow the instructions on the next page to complete the Enclosed Election form," the instruction page was not included. Accordingly, the court concluded that the notice fails to adequately explain the plan's procedures for electing coverage. As such, the court held that the Neptune notice fails to provide sufficient information of COBRA rights, and stated that an appropriate judgment will be entered against Neptune for this failure.

June 30, 2015

Employee Benefits-IRS Provides Penalty Relief Program for Form 5500-EZ Late Filers

In Employee Plans News, Issue No. 2015-7, June 23, 2015, the IRS discusses the new penalty relief for Form 5500-EZ Late Filers. Here is what the IRS said.

Retirement plan sponsors who missed filing required annual reports may be eligible for penalty relief under Revenue Procedure 2015-32.

Plans eligible

• One-participant plans covering a 100% owner or a partnership, and their spouses (no other participants). Non-ERISA plans only.

• Foreign plans subject to IRS annual reporting that are maintained outside the U.S. primarily for non-resident aliens.

Plans subject to Title I of ERISA aren't eligible. Instead, use the Department of Labor's Delinquent Filer Voluntary Compliance Program.

Forms covered

• Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan.

• Form 5500, Annual Return/Report of Employee Benefit Plan, if you filed this return because your non-ERISA plan didn't meet the filing requirements for Form 5500-EZ for plan years before 2009.

If you've received a delinquency notice for the overdue form, you can't use this penalty relief program for that year's return. The delinquency notice is CP 283, Penalty Charged on Your Form 5500 Return.

How to apply

1. Each plan must be submitted separately. All delinquent returns for a single plan may be submitted together.

2. Prepare delinquent returns. Prepare a paper Form 5500-EZ for each delinquent year, including any required schedules and attachments.

• 1990-current delinquent Form 5500-EZ- use the correct Form 5500-EZ for that year.

• Pre-1990 delinquent Form 5500-EZ- use the current year Form 5500-EZ.

• Form 5500 required for the delinquent year - use the current year Form 5500-EZ, filled out with the beginning and ending dates for the plan year for which the return was delinquent.

3. Write in red at the top of each paper return: "Delinquent Return Filed under Rev. Proc. 2015-32, Eligible for Penalty Relief."

4. Complete Form 14704. Attach this Transmittal Schedule to the top of your submission (including all delinquent returns).

5. Pay the required fee. The fee is $500 per delinquent return, up to $1,500 per plan. Make your check payable to "United States Treasury."

6. Mail your returns. Electronically filed delinquent returns are not eligible for penalty relief.

First class mail

Internal Revenue Service
1973 North Rulon White Blvd.
Ogden, UT 84404-0020

Private delivery services

Internal Revenue Submission Processing Center
1973 North Rulon White Blvd.
Ogden, UT 84404

Penalties that otherwise apply

Without the program, a plan sponsor faces many potential late filing penalties, including:

• $25 per day, up to $15,000 for each late Form 5500 or 5500-EZ, plus interest (IRC Section 6652(e)).

• $1,000 for each late actuarial report (IRC Section 6692)

Reasonable cause for late filing

As an alternative to submitting late returns under this delinquent filer program, you may instead request relief by attaching a statement to your delinquent return, signed by a person in authority, stating your reasonable cause for the untimely return. However, if the request is denied, you will receive a penalty notice (CP 283) and the return will no longer be eligible for this delinquent filer program.

June 26, 2015

Employee Benefits-Supreme Court Rules That Code Section 36B Tax Credits (That Is, The Health Care Subsidies) Are Available When Health Insurance Is Purchased On A Federal Exchange

In King v. Burwell, No. 14-114 (Supreme Court 2015), the Court faced a key question arising under the Affordable Care Act.

The Background: The Affordable Care Act contains a number of reforms, including:

-- the requirement that individuals either purchase health insurance coverage or pay a penalty to the IRS (unless the cost of purchasing insurance would exceed eight percent of that individual's income);

--making insurance more affordable by giving refundable tax credits, under section 36B of the Internal Revenue Code, to individuals with household incomes between 100 percent and 400 percent of the federal poverty line; and

--requiring the creation of an "Exchange" in each State--basically, a marketplace that allows people to compare and purchase health insurance plans.

The Exchanges, Tax Credits And The Issue: The Affordable Care Act gives each State the opportunity to establish its own Exchange, but provides that the Federal Government will establish "such Exchange" if the State does not. Relatedly, the Act provides that tax credits "shall be allowed" for any "applicable taxpayer," but only if the taxpayer has enrolled in an insurance plan through an Exchange established by the State. Section 36B(a) -(c). The Issue becomes whether the tax credits are available when the individual has enrolled in (that is, purchases) health insurance offered under an Exchange established by the Federal Government. An IRS regulations indicates that the tax credits are so available.

Holding By The Court: Section 36B's tax credits are available to individuals in States that have a Federal Exchange, and who purchase health insurance through that Federal Exchange.

June 16, 2015

Employee Benefits-IRS Issues New Listing of Required Modifications (LRMs)

In Employee Plans News, Issue No. 2015-6, June 10, 2015, the Internal Revenue Service (the "IRS") issues an extensive, new Listing of Required Modifications (LRMs). The new listing is here. The IRS call the new listing a collection of information packages designed to assist sponsors who are drafting or re-drafting plans to conform with applicable law and regulations. The new listing includes LRMs for cash balance plans, ESOPS, 403(b) plans, defined benefit plans, defined contribution plans and CODAs.

June 15, 2015

Employee Benefits-IRS Announces That Its Pre-Approved Plan Program Is Expanded to Include Cash Balance Plans and ESOPs

In Employee Plans News, Issue No. 2015-6, June 10, 2015, the Internal Revenue Service (the "IRS") announces that its pre-approved plan program is expanded to include cash balance plans and ESOPS. Here is what the IRS said.

Revenue Procedure 2015-36 updates existing guidance on master & prototype and volume submitter plan applications for opinion and advisory letters. Important changes in the new revenue procedure include:

• Extending the application deadline for pre-approved defined benefit plans from June 30 to October 30, 2015,
• Opening the pre-approved plan program to cash balance plans for submission by October 30, 2015, and
• Expanding the pre-approved plan program to employee stock ownership plans (ESOPs) during the defined contribution application period beginning February 1, 2017.

Concurrent with the new revenue procedure, the IRS has also released sample language - Listings of Required Modifications (LRMs) - for pre-approved cash balance plans and ESOPs.

Converting individually designed plans into pre-approved plans

Employers currently maintaining individually designed plans that intend to adopt pre-approved cash balance plans or ESOPs (when available) should complete Form 8905, Certification of Intent To Adopt a Pre-approved Plan, before the end of their plan's current 5-year remedial amendment cycle. This form serves as a record of the employer's intention to transition from an individually designed plan to a pre-approved plan. See the FAQs on Form 8905 and Revenue Procedure 2007-44, Part IV for further information.

If an employer doesn't know which particular pre-approved plan it will ultimately adopt the employer does not need to complete Part II or the information in Part III, line 4, of Form 8905 (requiring identifying information on the pre-approved plan and certification by the M&P sponsor or VS practitioner). Instead, attach a statement indicating that the employer intends to adopt a pre-approved cash balance plan or ESOP when the plan has received an opinion/advisory letter. The employer should keep a copy of the form and statement and attach them to any determination letter application (Form 5300, 5307 or 5310) they file.


June 11, 2015

Employee Benefits-Eighth Circuit Rules That Taxpayer Engaged In A Prohibited Transaction, When He Used An IRA To Fund A Business Which Paid Him Wages

In Ellis v. Commissioner of Internal Revenue, No. 14-1310 (8th Cir. 2015), the taxpayers were appealing from the decision of the tax court finding a deficiency in their income taxes and imposing related penalties. Upon reviewing the case, the Eighth Circuit Court of Appeals (the "Court") concluded that taxpayer Mr. Ellis engaged in a prohibited transaction with respect to his individual retirement account (the "IRA"), and affirmed the tax court's ruling.

In this case, an attorney for Mr. Ellis formed CST Investments, LLC ("CST"), to engage in the business of used automobile sales in Harrisonville, Missouri. The operating agreement for CST listed two members: (1) a self-directed IRA belonging to Mr. Ellis (owing 98% of the company,), and (2) Richard Brown, an unrelated person who worked fulltime for CST (owning the remainder of the company). Mr. Ellis was designated as the general manager for CST and given "full authority to act on behalf of" the company. The operating agreement also stated that "the General Manager shall be entitled to such Guaranteed Payment as is Approved by the Members."

Mr. Ellis's IRA did not exist at the time CST was formed. Rather, he established the IRA with First Trust Company of Onaga ("First Trust") in June 2005. On June 22, 2005, he received $254,206.44 from a 401(k) that he had established with his previous employer, and he deposited the amount in his IRA. He then directed First Trust as the custodian of the IRA to acquire 779,141 shares of CST at a cost of $254,000. On August 19, 2005, Mr. Ellis received an additional $67,138.81 from his 401(k), which he again deposited into the IRA. He directed First Trust to acquire an additional 200,859 shares of CST at a cost of $65,500. Mr. Ellis reported the transfers from his 401(k) to the IRA as non-taxable rollover contributions. To compensate him for his services as general manager, CST paid Mr. Ellis a salary of $9,754 in 2005 and $29,263 in 2006. While not clear if these were guaranteed payments per the operating agreement, Mr. Ellis had, at all times, the power to have CST make payments to him.

On March 28, 2011, the Commissioner of the Internal Revenue Service sent the taxpayers, the Ellises, a notice of deficiency and related penalties, based on a determination that Mr. Ellis engaged in prohibited transactions under 26 U.S.C. § 4975(c) by (1) directing his IRA to acquire a membership interest in CST with the expectation that the company would employ him, and (2) receiving wages from CST. The notice explained that, as a result of these transactions, the IRA lost its status as an individual retirement account and its entire fair market value was treated as taxable income. See 26 U.S.C. § 408(e)(2). The Ellises filed a timely petition in tax court to contest the notice of deficiency. The tax court upheld the Commissioner's determination, and the Ellises appealed.

In analyzing the case, the Court said that Code section 4975 limits the allowable transactions for certain retirement plans, including individual retirement accounts under § 408(a). It does so by imposing an excise tax on enumerated "prohibited transactions" between a plan and a "disqualified person." 26 U.S.C. § 4975(a). Prohibited transactions include any "direct or indirect . . . transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;" or "act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account." § 4975(c)(1)(D), (E). If a disqualified person engages in a prohibited transaction with an IRA, the plan loses its status as an individual retirement account under § 408(a), and its fair market value as of the first day of the taxable year is deemed distributed and included in the disqualified person's gross income. 26 U.S.C. § 408(e)(2).

The Court continued by noting that, here, it is undisputed that Mr. Ellis was a disqualified person under § 4975(e)(2)(A) because he was a fiduciary of his IRA (as he can direct asset investment). The parties also agree that CST was a disqualified person because Mr. Ellis was a beneficial owner of the IRA's membership in the company. See id. § 4975(e)(2)(G)(i) (including as a disqualified person a corporation in which 50 percent or more of the stock is owned by a fiduciary); id. § 4975(e)(4) (stating that ownership includes indirect ownership). Therefore, said the Court, the only issue on appeal is whether the payment of wages to Mr. Ellis was a prohibited transaction. The record establishes that Mr. Ellis caused his IRA to invest a substantial majority of its value in CST with the understanding that he would receive compensation for his services as general manager. By directing CST to pay him wages from funds that the company received almost exclusively from his IRA, Mr. Ellis engaged in the indirect transfer of the income and assets of the IRA for his own benefit and indirectly dealt with such income and assets for his own interest or his own account. This results in a prohibited transaction by Mr. Ellis with respect to his IRA, and the IRA's loss of its status as such with the corresponding deemed distribution to the Ellises in an amount equal to the former IRA's fair market value.