count in determining the top 20 percent of employees by compensation. Special rule for determining top-paid group for current year Under the Act, an employee will not be treated as in the top-paid group, as an officer, or as receiving more than $50,000 or $75,000 solely because of the employee's status during the current year, unless such employee also is among the 100 employees who have received the highest compensation during such year. Under this rule, an individual who was a highly compensated employee for the preceding year (without regard to the 1-year lookback or to the application of this special rule) remains highly compensated for the current year. Thus, the 100-employee rule is intended as a rule of convenience to employers with respect to new employees hired during the current year, with respect to increases in compensation, and with respect to certain other similar factors. If any employee is not a 5percent owner or within the top-100 employees by compensation for the current year (and was not a highly compensated employee in the preceding year (without regard to this special rule)), then that employee is not treated as highly compensated for the year, but will be treated as highly compensated for the following year if the employee otherwise falls within the definition of highly compensated employee. However, under the Act, an employer may elect not to apply the 100-employee rule for the current year. For example, assume that a calendar year employer has 12,000 total employees in 1990 and 1991, and for each year 4,000 employees may be disregarded in determining the number of employees that is to be treated as the number in the top-paid group. Thus, 1,600 (20 percent of 8,000) employees are in the top-paid group. This employer's highly compensated employees for 1991 will include the following: (1) any employee who owned at any time during 1990 or 1991 more than 5 percent of the employer; (2) any employee who, in 1990, (a) received more than $75,000 in annual compensation, (b) was an officer (for top-heavy purposes), or (c) received more than $50,000 in annual compensation and was among the 1,600 most highly compensated employees; and (3) any employee who, in 1991, (a) was an officer (for top-heavy purposes) or received more than $50,000 in annual compensation, and (b) was among the 100 most highly compensated employees. Thus, an employee who is not a highly compensated employee in 1990 (without regard to this special 100-employee rule) will not be treated as highly compensated for 1991, unless such employee either (1) acquires ownership of more than 5 percent of the employer in 1991 or (2) both becomes 1 of the 100 most highly compensated employees in 1991 and either is an officer or receives more than $50,000 in 1991. Of course, in this example, the minimum 1-officer rule also applies. Treatment of family members The Act provides a special rule for the treatment of family members of certain highly compensated employees. Under the special rule, if an employee is a family member of either a 5-percent owner or 1 of the top 10 highly compensated employees by compensation, then any compensation paid to such family member and any contribution or benefit under the plan on behalf of such family member is aggregated with the compensation paid and contributions or benefits on behalf of the 5-percent owner or the highly compensated employee in the top 10 employees by compensation. Therefore, such family member and employee are treated as a single highly compensated employee. For example, if the spouse of the most highly compensated employee of an employer is also an employee and participates in the employer's qualified cash or deferred arrangement, then (1) the elective deferrals made by the spouse and the compensation received by the spouse are aggregated with the elective deferrals made by, and the compensation received by, the most highly compensated employee for purposes of applying the special nondiscrimination test to the elective deferrals of the most highly compensated employee, and (2) the spouse is not treated as a separate employee. Such aggregation applies in the same manner without regard to whether the spouse is also a 5-percent owner or 1 of the top 10 highly compensated employees by compensation. An individual is considered a family member if, with respect to an employee, the individual is a spouse, lineal ascendant or descendant, or spouse of a lineal ascendant or descendant of the employee. The Act also clarifies that, even if a family member is excluded for purposes of determining the number of employees in the toppaid group, such family member is subject to the aggregation rule. Nonresident aliens With respect to the determination of the highly compensated employees of an employer, nonresident aliens who receive no U.S. source earned income from the employer are disregarded for all purposes. 23 Former employees Under the Act, a former employee is treated as highly compensated if the employee was highly compensated when (1) such employee separated from service or (2) at any time after the employee attained age 55. In addition, Congress intends that the Secretary is to prescribe rules treating an employee who performs only de minimis services as separated from service for purposes of determining whether such employee is a highly compensated employee. Scope of highly compensated employee definition Under the Act, the new definition of highly compensated employees applies for purposes of sections 79, 89, 106, 117(d), 120, 127, 129, 132, 274, 401(a)(4), 401(a)(5), 401(k)(3), 401(1), 401(m), 406(b), 407(b), 408(k), 410(b), 411(d), 414(m), 415(c), 423(b), 424(c), 501(c)(17), 501(c)(18), 505, and 4975 of the Code, and 29 U.S.C. sec. 1108. 23 A technical correction may be needed so that the statute reflects this intent. Compensation For purposes of identifying an employer's highly compensated employees, "compensation" is defined as compensation within the meaning of section 415(c)(3), increased by elective contributions under a cafeteria plan (sec. 125), qualified cash or deferred arrangement (sec. 401(k)), SEP (sec. 408(k)), and tax-sheltered annuity (sec. 403(b)). Effective Date The new definition of "highly compensated employee" is generally effective for years beginning after December 31, 1986, except to the extent that the substantive rule to which the definition relates is effective at a later time. Revenue Effect The provision is estimated to have a negligible effect on fiscal year budget receipts. C. Treatment of Distributions 1. Uniform minimum distribution rules (sec. 1121 of the Act and secs. 401(a)(9) and 4974 of the Code)1 Qualified plans Prior Law Under present and prior law, a trust is not a qualified trust unless the plan of which it is a part provides that the entire interest of each participant will be distributed no later than the participant's required beginning date (sec. 401(a)(9)). Alternatively, the requirements of present and prior law may be satisfied if the participant's entire interest is distributed in substantially nonincreasing annual payments, beginning no later than the participant's required beginning date, over (1) the life of the participant, (2) the lives of the participant and a designated beneficiary, (3) a period (which may be a term certain) not extending beyond the life expectancy of the participant, or (4) a period (which may be a term certain) not extending beyond the life expectancies of the participant and a designated beneficiary. Under prior law, a participant's required beginning date generally was April 1 of the calendar year following the calendar year in which (1) the participant attained age 701⁄2 or (2) the participant retired, whichever was later. If a participant was a 5-percent owner with respect to the plan year ending in the calendar year in which the participant attained age 702, then the required beginning date under prior law was generally April 1 of the calendar year following the calendar year in which the participant attained age 701⁄2 even if the participant had not retired. In addition, under present and prior law, the distribution of benefits under a qualified plan is required to satisfy an incidental benefits rule.2 Under the incidental benefits rule, a qualified plan generally is required to provide for a form of distribution under which the present value of the payments projected to be made to the participant, while living, is more than 50 percent of the present value of the total payments projected to be made to the participant and the participant's beneficiaries. However, a distribution pattern is not prohibited by the incidental benefits rule to the extent that it is required by the rules relating to qualified joint and survivor annuities. Present and prior law provides a minimum distribution requirement with respect to benefits payable from a qualified plan with 1 For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, sec. 1121; H.Rep. 99-426, pp. 724-727; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 1221; S.Rep. 99-313, pp. 603-607; and H.Rep. 99-841, Vol. II (September 18, 1986), pp. 449-452 (Conference Report). 2 See, e.g., Rev. Rul. 72-241, 1972-1 Č.B. 108. respect to a participant who has died. The minimum distribution requirements vary depending upon whether benefit payments commenced before or after the participant's death. Tax-sheltered annuities With respect to tax-sheltered annuities and custodial accounts (Code sec. 403(b)), present and prior law provides minimum distribution rules similar to the rules for qualified plans.3 IRAS 3 Present and prior law provides before- and after-death minimum distribution rules for individual retirement arrangements (IRAs) generally corresponding to the rules applicable to qualified plans. Distributions from an IRA, however, are required to commence no later than April 1 of the calendar year following the calendar year in which the owner of the IRA attains age 70% without regard to whether the owner has separated from service with an employer. Rollover restrictions Under prior law (as amended by the technical corrections provisions of the Tax Reform Act of 1986), a 5-percent owner was not permitted to make a rollover contribution to a qualified plan (secs. 401(a) and 403(a)). This rule applied to prevent avoidance of the 10percent additional income tax on early withdrawals through taxfree rollovers to other qualified plans. Reasons for Change Congress was aware that the current absence of uniformity in the minimum required distribution rules applicable to tax-favored plans created significant disparities in opportunities for tax deferral among individuals covered by different types of plans. Uniform rules eliminate such disparities and reduce the complexity of the existing rules. In particular, for most employees, prior law used separation from service with an employer after age 70% as the event triggering the required commencement of benefit payments from a qualified plan. However, in the case of a 5-percent owner of an employer or an IRA owner, the attainment of age 70% without regard to separation from service triggered the required commencement of benefits. Thus, the prior-law rules allowed longer deferrals of tax on accumulations under a qualified plan for participants who were not 5percent owners. Further, the time of separation from service was sometimes difficult to determine, as in the case of employees who ceased their regular duties, but continued to work under consulting agreements in order to postpone commencement of retirement benefit payments. Congress believed that a uniform benefit commencement date for all tax-favored retirement arrangements eliminated the disparities among various types of retirement vehicles, and eased administrative burdens in the private and public sectors by eliminating the 3 The technical corrections provisions of the Act make it clear that both the before- and afterdeath distribution rules applicable to qualified plans also apply to all tax-sheltered annuities and custodial accounts, effective with respect to benefits accrued after December 31, 1986. |