2007 Employee Benefits Deadlines Require Immediate Attention

December 4, 2007

As another year comes to a close, employers must take a number of actions to (i) address Section 409A of the Internal Revenue Code for deferred compensation plans, (ii) comply with the Labor Department’s "qualified default investment alternative" ("QDIA") fiduciary safe harbor for defined contribution retirement plans, and (iii) begin operating their qualified retirement plans in compliance with new rules that become effective on January 1, 2008. In addition, employers whose employer identification numbers end with "2" or "7" need to file their tax-qualified plans for an IRS determination letter by January 31, 2008. 

Section 409A Actions

Notice 2007-86 extended most of the Section 409A transition rules to December 31, 2008. See our October 23, 2007 client alert . However, the following actions need to be taken by December 31, 2007 in order to comply with Section 409A:

• New payment elections can be made in 2007 with respect to amounts subject to Section 409A, as long as those elections do not move payments into or out of 2007. A similar rule applies for 2008. Thus, in order to move payments into or out of 2008 (e.g., to elect payment in 2008 of an amount currently scheduled to be paid in 2011), action must be taken by December 31, 2007.
• Deferral elections for non-"performance-based compensation" to be earned in 2008 generally must be made by December 31, 2007.
• IRS Notice 2007-86 generally extended to December 31, 2008 the deadline for "fixing" stock options and stock appreciation rights that were "in the money" when granted. (The deadline was December 31, 2006 for certain options granted to Section 16 officers and directors, and that deadline was not extended.) The correction can be effected by either increasing the option/SAR exercise price to the fair market value of the underlying shares as of the date of grant or by "hard-wiring" the exercise date for a year other than the year in which the correction is made. In addition, if an employer wishes to make employees whole with a cash payment or other consideration in connection with an increase in the exercise price, the payment cannot be made in the year the correction is made. Thus, if there is a desire to either correct in- the- money options/SARs by hard-wiring the exercise date for 2008 or to make grantees whole with a cash payment or transfer of other consideration in 2008, action needs to be taken by December 31, 2007.

In addition, on December 3 the IRS released a new voluntary correction program for certain Section 409A violations. We plan to send out a client alert addressing the program later this week.

QDIA Safe Harbor

On October 23, 2007, the Labor Department issued final regulations setting forth the standards applicable to QDIAs. If the regulations’ requirements are satisfied, a fiduciary of a defined contribution plan that permits participants to direct investment of their accounts generally will be relieved of liability for losses experienced by participants whose account is invested in the QDIA due to the participant’s failure to elect another investment alternative. The regulations generally become effective on December 23, 2007. See our October 24, 2007 client alert.

Tax-Qualified Retirement Plans

A number of actions need to be taken both to bring plans into compliance with law changes made by final regulations under Section 415 of the Internal Revenue Code and the Pension Protection Act of 2006:

• In April 2007, final regulations under Section 415 of the Code were issued. See our April 16, 2007 client alert.  The most significant change made by the regulations is regarding the treatment of severance pay. The final regulations (along with concurrent changes to the Code Section 401(k) regulations) provide that terminated employees generally may not make 401(k) elective deferrals from compensation payable after termination of employment and that such payments do not qualify as "compensation" for purposes of the Code Section 415 limitations. The final regulations generally are effective for limitation years beginning on or after January 1, 2008. Although the regulations must be applied operationally beginning January 1, 2008 for most plans, plan amendments are not required until the tax return due d ate for the employer’s 2008 tax year (generally September 15, 2009 for calendar year taxpayers).
• The Pension Protection Act of 2006 made a number of changes to the rules regarding plan qualification and distributions. See our August 8, 2006 detailed summary. Some of the key changes that are effective January 1, 2008 include:
  • Changes to the funding rules (which generally require faster funding of defined benefit plans) become effective for most plans.
  • The modified interest rate for determining lump sum distributions — generally based on a corporate bond yield curve rather than 30-year Treasury rates — begins to be phased in over five years.
  • Defined benefit and money purchase pension plans generally must make a 75% qualified joint and survivor annuity form of distribution available.
  • Cash balance and similar plans must provide that the benefits of any participant with an hour of service on or after January 1, 2008 must vest at least as quickly as under a three-year "cliff" vesting schedule. This will require changes to most such plans, which typically provide for vesting after five years of service.
  • An automatic enrollment safe harbor becomes available for 401(k) plans. It is fairly similar to the longstanding 401(k) safe harbor for pre-tax deferrals and matching contributions and permits plans to avoid "ADP" and "ACP" nondiscrimination testing.
  • Direct rollovers from qualified plans to Roth IRAs are permitted.

Determination Letter Applications

In Revenue Procedure 2005-66, the IRS implemented a system of staggered five-year remedial amendment cycles for individually designed plans and opened the determination letter program for changes made by the Economic Growth and Tax Relief Reconciliation Act of 2001 and subsequent legislation. The filing deadlines generally vary based on the last number in the employer’s identification number ("EIN"). Plan sponsors whose EINs end in "2" or "7" must file applications for their plans no later than January 31, 2008 in order to be protected by the "remedial amendment period." The program then opens from February 1, 2008 through January 31, 2009 for employers whose EINs end in "3" or "8".