213 Medical Expenses, ISO/ESPP Information Reporting, 401(K)/403(B) Contribution Limits, FICA Tax Triggered upon “Retirement”

Focus On Employee Benefits

Health & Welfare: 213 Expenses

Susan Relland and Patricia Szoeke

The IRS has issued new guidance on whether amounts paid for certain diagnostic procedures and devices are qualified medical expenses under Code Section 213. Revenue Ruling 2007-72 addresses the following three scenarios: an annual physical exam performed by a physician, a full-body electronic scan performed at a clinic, and an over-the-counter pregnancy test. The ruling concludes that all three expenses were incurred for diagnosis purposes, even though the taxpayer was not experiencing any symptoms of illness, and therefore are qualified expenses under Code Section 213.

This is the first IRS guidance on the qualified status of over-the-counter pregnancy tests. Employers may want to review their plan documents to determine whether they need amending to allow for reimbursement from a health Flexible Spending Arrangement or Health Reimbursement Arrangement. If the current plan includes a broad definition of covered expenses, no amendment may be necessary; however, most plan documents do not include such broad language and will probably need amended if the employer wants to cover reimbursement of over-the-counter pregnancy tests. Note that over-the-counter pregnancy tests are now eligible for tax-free reimbursement from a Health Savings Account without needing to amend any documents.


Exec Comp: ISO/ESPP Information Reporting

Fred Oliphant and Patricia Szoeke

The IRS has recently issued interim guidance (Notice 2008-8) addressing a corporation's obligation under Code Section 6039, as amended by the Tax Relief and Health Care Act of 2006 (Act), to provide the IRS with an information return upon certain stock transfers that occur on or after January 1, 2007. However, because Treasury has not yet issued regulations under amended Code Section 6039, the Notice indicates that the IRS is waiving the requirement to make an information return for 2007 stock transfers. Corporations should, however, continue to give employees the information required by the existing regulations under Section 6039.

Prior to January 1, 2007, Code Section 6039 required corporations to provide a written statement to each employee upon (1) the corporation's transfer of stock upon the employee's exercise of an incentive stock option (ISO) described in Code Section 422(b) and (2) the employee's transfer of stock that was acquired pursuant to the exercise of a stock option described in Section 423(c). Such statements were required to be furnished no later than January 31 of the year following the year for which the statement is required and the existing regulations under Section 6039 detail the contents of the statements. The Act amended Code Section 6039 to require that information return upon such stock transfers that occur during the 2007 calendar year and later. At this time, the IRS anticipates that the forthcoming regulations will retain the existing rules with regard to the content of the employee statements and will generally require the same information to be included in the information returns provided to the IRS.


Qualified Plans: 401(k)/403(b) Contribution Limitations

Adrian Morchower and Patricia Szoeke

If an individual participates in both a qualified 401(k) plan and a 403(b) plan, plan sponsors may be required to look at contributions made to both plans when determining if the contribution limits are satisfied. Two different limits apply to contributions to a qualified plan and both must be met in order to avoid adverse tax consequences.

Code Section 402(g) limits the total elective deferrals (i.e., contributions made through salary reduction agreements) by any individual to all plans (including 401(k) and 403(b)) in which the individual participates. For the 2008 calendar year, the 402(g) limit is $15,500. Where the individual is age 50 or older, an additional "catch-up" contribution of up to $5,000 for the 2008 calendar year may be made. Furthermore, if an individual has at least 15 years of service with an organization sponsoring a 403(b) plan, an additional $3,000 may be added to the limit on elective deferrals for contributions to the individual's 403(b) account. When determining if the elective deferral limitations are met, one must take into account elective deferrals made to both 401(k) and 403(b) plans.

Code Section 415(c) limits the amount of annual additions (i.e., elective deferrals, after-tax contributions, and employer contributions) to a fixed dollar amount. For the 2008 calendar year, the limit is the lesser of $46,000 or 100% of the participant's compensation. Although this limit generally applies on a plan-by-plan basis, plans maintained by the same or related employers may need aggregated when applying the $46,000 limit. For purposes of plan aggregation, where an employee has more than 50% control of a corporation, partnership, or sole proprietorship, any annuity contract under Code Section 403(b) is treated as a defined contribution plan maintained by each employer with respect to which the participant has at least a 50% interest. Thus, if an employee of a university receives a Code Section 403(b) annuity contract from the university and has at least a 50% interest in a corporation that sponsors a 401(k) plan, the 403(b) and 401(k) plans would need to be aggregated when applying the Code Section 415(c) limit.


Payroll Tax & Fringe Benefits: FICA Tax Triggered upon "Retirement"

Fred Oliphant and Gary Quintiere

Many companies have been surprised to learn that a feature in their incentive plan may cause them to incur FICA tax on awards earlier than they expected.  The feature in question is one that is found in many incentive plans, particularly those plans that grant restricted stock units (RSUs), that vest awards early if the grantee "retires."  An example is an arrangement that grants RSUs that normally vest and pay out upon the completion of a specified period of service, such as three years, but also has a feature that states if a grantee "retires" in the interim, the awards will vest at that time and be paid out early on retirement.  If "retirement" under the arrangement merely means termination after attaining a specified age or a combination of a specified age and years of service, and if there is no way that a grantee who is retirement eligible under such standard can forfeit or lose the RSUs thereafter, then it is likely that the grantee will be regarded as vested once he or she first becomes retirement eligible, even if the grantee has not actually terminated employment.  In such circumstances, the early vesting will trigger the application of FICA tax under Code Section 3121(v) at a time that is earlier than actual payment.  It should also be noted that this same feature may adversely affect the ability to treat the award as a short-term deferral under Section 409A.

For further information, please contact any of the following lawyers:

Fred Oliphant, foliphant@milchev.com, 202-626-5834

Gary Quintiere, gquintiere@milchev.com, 202-626-1491

Adrian Morchower

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