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Two New IRS Private Letter Rulings Allow Retiree Cashouts

Author, Donna Edwards, Atlanta, +1 404 572 2701, dedwards@kslaw.com.

The IRS recently issued two Private Letter Rulings (PLR 201228045 and PLR 201228051) addressing whether the minimum distribution requirements of Section 401(a)(9) of the Internal Revenue Code (the "Code") would be violated by a company if it amended its defined-benefit pension plans to offer a lump sum payment option, during a limited "window" period, to the plans' participants and beneficiaries for whom annuity payments had already begun.

The IRS described the company in each of the rulings as one that manufactures, assembles, and sells goods both in the United States and throughout the world. Much speculation has tied the rulings to the recent retiree cashout programs announced by General Motors and Ford.

In each of the rulings, the company proposed to amend its plans to offer the covered participants a period (between 60 and 90 days in one of the rulings and between 30 and 60 days in the other) during which to elect to receive the actuarial present value of their remaining plan benefits in the form of a lump sum payment. As an alternative, the covered participants were given the ability to elect to receive the actuarial present value of their remaining benefits in either a qualified joint and survivor annuity or a qualified optional survivor annuity. The elections by the covered participants were to be subject to applicable spousal consent, and any covered participants electing a new distribution option were to be considered to have a new annuity starting date as of the first day of the month in which their new benefit was payable.

In one of the rulings, the company explained that the benefit obligations attributable to its plans and reported on its financial statements were disproportionately large and very sensitive to swings in interest rates, that over time the obligations skewed disproportionately towards retirees, that the company's industry is susceptible to global economic changes, that swings in interest rates and changes in economic conditions have caused the plans' pension obligations to be very volatile, and that this volatility increased the cost of financing, making cash flow management (including plan contributions) more difficult and making the company less competitive in the marketplace.

The company argued that the proposed amendment would reduce the impact of the volatility of the large pension obligations.

The IRS in both rulings noted that Code Section 401(a)(9), which provides rules relating to required minimum distributions from qualified plans, was enacted to ensure that the amounts contributed to qualified retirement plans were used for retirement by requiring benefit payments to begin by a certain date with no less than a certain amount distributed each year. The IRS then explained that the Code Section 401(a)(9) regulations allow an annuity payment period to be changed, and the annuity payments to be increased, in association with a plan amendment that increases plan benefits.

The IRS concluded in both rulings that because the ability to elect the lump sum option would only be available during a limited period, the increased benefit payments would result from a plan amendment increasing plan benefits, and the change in the annuity payment period would be in association with that plan amendment, each as permitted by the regulations.

The IRS noted in the rulings that any participant who elects the lump sum option will be considered to have a new annuity starting date. This means that the participant must also be given the right to elect a qualified joint and survivor annuity form or a qualified preretirement survivor annuity form in lieu of the lump sum payment form, and that applicable spousal consent rules will apply. In addition, the Code Section 415 limitations would need to be satisfied as of the new annuity starting date, taking into account the benefits that have been provided at each of the annuity starting dates.

Moreover, the IRS noted in one of the rulings that any portion of the lump sum payment that constitutes a required minimum distribution under Code Section 401(a)(9) would not constitute an eligible rollover distribution and thus could not be rolled over tax-free to an individual retirement account or any other eligible plan.

Finally, note that certain IRS rules may restrict the ability of a defined benefit pension plan to pay lump sums, depending on the funded status of the plan.

It is important to note that an IRS Private Letter Ruling may not be used or cited as precedent, and is applicable only to the taxpayer who requested it.

Before any company considers implementing a retiree cashout program under a defined benefit pension plan, we recommend the company seek its own IRS Private Letter Ruling approving the program. While obtaining an IRS Private Letter Ruling can be an expensive and time-consuming process, the protections offered by such a letter to the requesting company outweigh the risks of disqualifying the plan.

King & Spalding would be happy to assist you with any questions you have about the IRS Private Letter Rulings or implementing a retiree cashout program under your defined benefit pension plan.

409A Transition Relief Ends December 31 for Certain Severance and Other Employment Agreements

Author, Laura R. Westfall, New York, +1 212 556 2263, lwestfall@kslaw.com.

Employment, change in control, and severance agreements, as well as severance and deferred compensation plans, often condition payment upon the execution of a release or a noncompete or other employment-related condition. Any such provision that gives a former employee discretion over the timing of his or her payments violates Section 409A of the Internal Revenue Code of 1986, as amended ("Section 409A"), which governs nonqualified deferred compensation. Such provisions should be corrected before December 31, 2012 under available transition relief, in order to avoid the possible imposition of reporting requirements on employers, and tax and interest penalties on employees.

Conditional Payment Window Provisions

Section 409A imposes specific requirements on the timing of deferral elections and the designation of the time and form of payment of benefits paid under nonqualified deferred compensation plans and agreements, including salary and bonus deferral plans, supplemental executive retirement plans, certain stock option arrangements, stock appreciation right arrangements, and restricted stock unit plans (collectively, "NQDCPs"). NQDCPs often provide that benefit payments will be made within a specified period (e.g., 90 days) after an employee's termination, subject to the former employee's execution of a general release of claims or a noncompetition or nonsolicitation agreement prior to the expiration of the period (a "conditional payment window provision"). However, conditional payment window provisions violate Section 409A if the employee may choose his or her year of payment by delaying execution of the release, depending on when the termination occurs. Consider the following example:

Example: John Smith's employment agreement provides that he will receive a lump-sum severance payment within 60 days after his termination from employment, subject to his execution and nonrevocation of a general release of claims within 45 days after his termination, and his non-revocation of such release within 7 days after such execution. Mr. Smith is terminated effective Nov. 31, 2012. If Mr. Smith executes the release on Dec. 1, 2012, his employer may pay the severance benefit as early as Dec. 8, 2012; however, if Mr. Smith waits to execute the release until Dec. 26, 2012 or later, his employer will not be able to pay the severance benefit until Jan. 1, 2013, due to the 7-day release revocation period. Because Mr. Smith decides when to execute the general release of claims, he controls whether his severance will be paid in 2012 or 2013. This control violates Section 409A.

Although payments made pursuant to a conditional payment window provision may not be subject to Section 409A if an exemption exists, each such provision should be examined to determine whether a correction is necessary.

Correction Methods and Transition Relief Through December 31, 2012

IRS Notice 2010-6, as modified by Notice 2010-80, provides that a noncompliant conditional payment window provision may be corrected as follows:

• If the provision designates a payment period of a set length, the provision must be amended to provide for payment to be made either (i) on the last day of such period or (ii) if the period spans two years, in the second year; or
  
  
• If the provision does not designate a payment period, the provision must be amended to provide for payment to be made either (i) on the 60th or 90th day following the event giving rise to the payment (such as an employee's termination date) or (ii) during a specified period not longer than 90 days following the event giving rise to the payment, except that if such period spans two years, the payment will automatically be made in the second year.

The transition relief described above is only available until December 31, 2012 and is subject to certain operational conditions. Further, in order to rely on this transition relief, an employer must take commercially reasonable steps to identify and correct all noncompliant conditional payment window provisions in its NQDCPs. For example, an employer cannot rely on the transition relief to correct a noncompliant conditional payment window provision in one employment agreements, unless the employer also corrects the noncompliant provisions in all its employment agreements.)

Any noncompliant conditional payment window provision in a NQDCP that is not corrected by December 31, 2012 will be deemed to violate Section 409A unless it can be corrected under another correction procedure. Any compensation paid to an employee pursuant to such a noncompliant provision may be required to be included in the employee's income when vested (not at payment), and may be subject to a 20% federal tax penalty, plus an interest penalty (in addition to ordinary income tax). In addition, employers may be subject to reporting and withholding requirements with respect to such compensation. Further, any correction of a noncompliant provision possible after December 31, 2012 will be subject to additional requirements (such as certain IRS filings), and may only protect employees from a portion of the tax penalties that would otherwise apply.

Next Steps

Given that the correction deadline is fast-approaching, we encourage employers to work with their counsel to identify all affected NQDCPs that include conditional payment window provisions, determine whether such provisions are compliant with Section 409A, and amend any noncompliant provisions by December 31, 2012. Note that such amendments may require the employee's consent and/or approval by the Compensation Committee of the employer’s Board of Directors. As always, King & Spalding will be happy to assist you in this process and in answering any other questions you may have on Section 409A generally.

2012 Year End Amendment Checklist

Authors, Eleanor Banister, Atlanta, +1 404 572 4930, ebanister@kslaw.com and James P. Cowles*, Atlanta, +1 404 572 3455, jcowles@kslaw.com.

Each year the IRS issues the Cumulative List of Changes in Plan Qualification Requirements (the "Cumulative List"). The Cumulative List is a listing of the statutory, regulatory and other guidance that may require an amendment to individually designed tax qualified retirement plans by year end. See Notice 2011-97 for the 2012 Cumulative List. The following is a brief overview of the plan provisions that may require an amendment by the end of the 2012 plan year.

Defined Contribution Plans that hold publicly traded employer securities that are "readily tradable on an established securities market" must satisfy certain diversification requirements. Notice 2011-19 revised the definition of "readily tradable on an established securities market". A plan that defines the phrase "readily tradable on an established securities market" may require an amendment.

Defined Benefit Plans generally will need to be amended to provide for certain funding-based limits on accelerated benefit payments and benefit accruals if a plan does not satisfy certain funding requirements. IRS Notice 2011-96 provides a sample amendment.

Benefits Insight: If your plan has already been amended for the funding based limitations, we recommend reviewing your plan amendment against the sample amendment to determine if further revisions are required or may be beneficial.

You may also refer to our September 2012 newsletter for an article describing the notice requirements for funding-based benefit limitations.

Governmental Plans must be amended to incorporate provisions of The Heroes Earnings Assistance Relief Act of 2008 (HEART Act) (generally effective as of January 1, 2007) relating to qualified military duty, and The Worker, Retiree, and Employer Recovery Act of 2008 (WRERA), which eliminated the requirement to make required minimum distributions for the 2009 calendar year. IRS Notice 2009-82 provides a sample amendment.

Puerto Rico Plans that cover residents of Puerto Rico must be amended to comply with changes required under Puerto Rico law.

Favorable Determination Letter Applications may be filed by employers with a two (2) or seven (7) as the last digit of their Employer Identification Number on or before January 31, 2012 for their individually designed tax qualified plans.

In addition, please refer to the Upcoming Filing and Notice Deadlines for Qualified Retirement and Health and Welfare Plans calendar in this newsletter for additional deadlines that may affect your plans.

King & Spalding would be glad to assist in reviewing your qualified plans to determine what amendments may be required by year end or assist in making application for a favorable determination letter.

*Non-lawyer Employee Benefits Consultant

Filing and Notice Deadlines for Qualified Retirement and Health and Welfare Plans

Author, R. Ryan Gorman, Atlanta, +1 404 572 4609, rgorman@kslaw.com.

Employers and plan sponsors must comply with numerous filing and notice deadlines for their retirement and health and welfare plans. Failure to comply with these deadlines can result in costly penalties and excise taxes. To avoid such penalties and excise taxes, employers must remain informed with respect to the filing and notice deadlines associated with their plans.

The filing and notice deadline table below provides key filing and notice deadlines common to calendar year plans. Please note that the deadlines will be different if your plan year is not the calendar year. Please also note that the table does not include all applicable filing and notice deadlines, just the most common ones. King & Spalding is happy to assist you with any questions you may have regarding compliance with the filing and notice requirements for your employee benefit plans.

The contents of this newsletter and any attachments are not intended to be and should not be relied upon as legal advice. If you are not currently on our Employee Benefits & Executive Compensation Practice mailing list under your own name, and you would like to join to receive our monthly Compensation & Benefits Insights publication and to receive notices of future programs and occasional commentaries on new legal developments in the industry, you can make that request by submitting your full contact information to CBI@kslaw.com.

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