[35] accountants and tax lawyers have been refusing to attempt the computations. The committee believes that this situation cannot be permitted to continue. For this reason, it has provided a new method of taxing such lump-sum pension distributions which is relatively simple and yet at the same time equitable. Under the new provision, that portion of the distribution representing pre-1974 value receives capital gains treatment. The balance of the lump-sum distribution is to be taxed as ordinary income under a separate tax schedule (the tax schedule applicable to single people) generally without reductions, exclusions, or consideration of the taxpayer's other income. However, to insure that the tax paid by lower income individuals on their lump-sum distributions will generally not be more than under present law, a special minimum distribution allowance is provided under the separate tax rate schedule. In addition, averaging relief is provided for the portion of the lump-sum distribution which is taxed as ordinary income under the separate tax rate schedule by providing 15 year averaging for such income. This in effect provides a tax payable at the time of the distribution, but no greater in amount than the taxpayer could expect to pay were the income to be spread over his remaining life expectancy. III. REVENUE EFFECT There are several different kinds of revenue effects which can be expected to arise from this bill. These are summarized in table 1. First, three provisions designed to equalize the tax treatment of pensions have an impact on tax deductions. These are the provisions raising the maximum deductible amount that the self-employed can set aside annually for their retirement, making provision for a retirement savings deduction for those not now covered under any retirement provisions, and a provision which limits the tax deduction of a limited number of proprietary-employees of corporations. Tax revenues are also affected by the modification of the tax treatment of lump-sum distributions. A third category of revenue effect occurs as a result of the imposition of two new taxes. One of these is the audit fee tax, designed to pay for the cost of the administration of pension plans by the Internal Revenue Service, and the second is the premium tax, to provide necessary revenue for plan termination insurance. However, since both of these taxes are deductible for income tax purposes, the revenue gain which would otherwise occur is decreased to some extent. Finally, a fourth category of revenue effect from the bill arises not because of any change in tax deductions as such, but rather because amounts are expected to be set aside for vesting and funding. The bill imposes additional requirements in the areas of vesting and funding which must be met if the present favorable treatment for pensions is to continue to be available. It is expected that these new requirements will result in employers making larger contributions to retirement plans, resulting in larger income tax deductions. [36] Table 1.-Estimated annual revenue effects of the Comprehensive Private Pension Security Act of 1973 at 1973 levels of income and employment I. Provisions designed to equalize tax treatment under pension plans: 1 Allowing individuals not covered by pension plans to deduct up to Total, provisions designed to equalize tax treatment under pension Millions -$175 -270 +125 -320 II. Revised tax treatment of lump-sum distributions from qualified plans +35 III. Revenue effect of new taxes: Audit fee tax of $1 a year for each employee covered by plan1 (to +30 Tax to finance plan termination insurance (50¢ or 70¢ per plan +18 Gross revenue collections___ +48 Revenue loss due to tax deductions taken by employers: -14. 4 Case 1: Assuming that the additional employer contributions to -130 Case 2: Assuming that the additional employer contributions to pen- -265 Case 3: Assuming that benefit levels of pension plans are adjusted 1 Takes effect Jan. 1, 1974. Takes effect Jan. 1, 1974, for proprietary plans adopted after July 24, 1973, and Jan. 1, 1975, for proprietary plans in existence on July 24, 1973. Takes effect Jan. 1, 1975. The minimum vesting provision is effective Jan. 1, 1976, for plans in existence on the date of enactment. For plans adopted after the date of enactment, the vesting requerement applies to plan years beginning after the enactment date. Existing plans which have been subject to collective bargaining agreements are not subject to the vesting requirement until the the expiration of the collective bargaining agreement or 1981, whichever is sooner. NOTE. There will be some revenue loss from funding but data are not available to determine the extent of this loss. Provisions designed to equalize tax treatment of pensions.-It is estimated that the provision increasing the maximum deductible pension contributions by self-employed persons on their own behalf to 15 percent of earned income up to $7,500 a year will result in an annual long term revenue loss of $175 million. The provision allowing individuals not covered by pension plans to deduct up to $1.000 a year 0 [37] for contributions to personal retirement plans is expected to involve a revenue loss amounting to $170 million in 1974 and rising to $270 million by 1977 (at 1973 income levels). On the other hand, extending the same limitations that apply to deductible pension contributions of self-employed people to proprietary employees (who own a 2 percent interest in the stock of the corporation and who together account for 25 percent of the present value of the accrued benefits under the plan) is expected to increase annual revenue by $125 million a year by 1975. Altogether, when fully effective, these three provisions involve an estimated annual net revenue loss of $320 million. Tax treatment of lump-sum distributions.-The revised tax treatment of lump-sum distributions from qualified plans (which provides for taxing that part of lump-sum distributions which is attributable to 1974 and later years as ordinary income under a separate tax rate schedule) is expected to result in relatively small increases in revenue over the next few years since the bulk of the lump-sum distributions in such years will be attributable to pre-1974 years. However, after a transition period, this provision can be expected to result in annual revenue gains amounting to $35 million a year based on 1973 levels of income. New taxes and their effect on income tax deductions.-An audit fee tax of $1 a year for each employee covered by a pension, profit-sharing, or stock bonus plan is expected to produce an estimated $30 million of revenue annually. The proceeds of this tax are allocated by the legislation for financing the Internal Revenue Service administration of provisions relating to pension plans and exempt organizations. The second new tax is imposed on employers with qualified plans and is to be used to finance plan termination insurance (50 cents or 70 cents per plan participant, depending on whether the employer has liability for losses) which is effective January 1, 1975. This tax is expected to raise an estimated $18 million annually. However, there is an offset to the revenue gain expected from the two new taxes. Employers can take income tax deductions for the new taxes which, of course, will have the effect of reducing the net cost of these taxes to them. It is estimated that an annual revenue loss of $14.4 million will be incurred in 1974, and later years, as a result of deductions taken for payments of the audit fee tax; similarly it is estimated that revenue will be reduced $9 million a year in 1975, and later years, as a result of deductions taken for the taxes required to be paid to finance plan termination insurance. These deductions against income tax reduce the revenue from the new taxes from $48 million to about $24 million. Revenue effect of minimum vesting and funding provisions.-The new minimum vesting standard, which becomes effective January 1, 1976, will also involve an indirect loss of revenue, ranging from zero to an estimated $265 million a year (at 1973 income levels). The minimum vesting requirement involves little or no revenue loss to the extent that plans adjust their benefit levels to absorb the increased employer costs resulting from the requirement. This is because, in that event, the requirement would have no effect on the deductions taken for contributions to plans or on the taxable income of covered employees. If the additional amounts required to be contributed to [38] pension plans as a result of the vesting standard are a substitute for cash wages rather than a net addition to cash wages the annual revenue loss is estimated at $130 million. This could occur, for example, if the additional employer payments into the pension plan are taken into consideration in setting future wage increases. In this event, the revenue loss results from the fact that the covered employees are permitted to postpone payment of tax on the employer contributions involved, instead of being required to pay tax currently, as would be the case had they received an equivalent amount of wages. Some part of this postponed $130 million of taxes presumably will be recovered in the future in tax payments on the benefits paid out by the plan. The upper range of the estimate, $265 million, represents the revenue loss if it is assumed that the additional employer payments into the pension plans required by the new vesting standard constitute an addition to the cash wages that will be paid in any event. In this case employers will have larger total wage bills (for the sum of cash wages and wage supplements) and hence will take larger tax deductions, giving rise to a $265 million revenue loss. It appears to the committee that realistically there is likely to be a combination of the three effects suggested above. However, it appears probable that the annual revenue loss will be in the vicinity of $130 million, the mid-point of the range. No revenue estimate is given for the increased funding requirements under the bill. Data are not available which would make a precise estimate of this type possible. However, it is believed that the minimum funding requirements will have a relatively modest revenue effect. IV. GENERAL EXPLANATION A. Administration Title I of the bill establishes an office in the Internal Revenue Service to facilitate the administration of tax provisions relating to pension (profit-sharing, etc.) plans, and also provides for certain clearinghouse functions for the Social Security Administration with regard to employees who leave employment with deferred vested benefits before being eligible for current retirement benefits. The provisions relating to the new office in the Internal Revenue Service are discussed at "H. Enforcement," below. Briefly, those provisions establish an Office of Employee Plans and Exempt Organizations, to administer the parts of the tax laws relating to these plans and organizations. The bill also authorizes appropriations to fund these activities, in the amount of the sum of (1) the collections from a new tax imposed with regard to employee plans under this bill and (2) half of the existing tax on investment income imposed on private foundations. The bill's provisions relating to the Social Security Administration. clearinghouse function are discussed under "E. Portability," below. Under those provisions, each pension (or profit-sharing, etc.) plan is to report to the Social Security Administration the vested benefit status of employees who leave employment with the employer who established the plan. When the employee (or his survivors) apply for [39] Social Security benefits (or on certain other occasions) the Social Security Administration is to notify the employee (or his survivors) if vested benefits are available under such a plan, as well as how to obtain benefits under the plan. B. Participation and Coverage (Secs. 201 and 261 of the bill and secs. 401 and 410 of the Code). 1. PLAN PARTICIPATION--AGE AND SERVICE REQUIREMENTS Present law The Internal Revenue Code does not generally require a qualified employer pension, profit-sharing, stock bonus, annuity, or bond purchase plan to adopt any specific age or service conditions for participation in the plan.1 Existing administrative practice allows plans to exclude employees who (1) have not yet attained a designated age or (2) have not yet been employed for a designated number of years, so long as the effect is not discriminatory in favor of employees who are officers, shareholders, supervisors, or highly compensated employees. Also, under administrative practice, a plan may exclude employees who are within a certain number of years of normal retirement age (for example, 5 years or less) when they would otherwise become eligible, if the effect is not discriminatory. On the other hand, in the case of a plan benefiting owner-employees,2 the plan must provide that no employee with 3 or more years of service may be excluded (sec. 401 (d) (3)). General reasons for change The committee believes that, in general, it is desirable to have as many employees as possible covered by private pension plans and to begin such coverage as early as possible, since an employee's ultimate pension benefits usually depend to a considerable extent on the number of his years of participation in the plan. This is particularly important for employees who, because of the nature of their employment, shift from employer to employer over their working careers. In addition, early participation tends to spread the cost of providing employees with adequate pensions more evenly over the various firms for which the employee has worked over his entire working career, instead of concentrating the cost on his last few employers. Of course, the general desirability of early participation must be balanced against the cost involved for the employer. Also from an administrative standpoint, it is not desirable to require coverage of transient employees, since benefits earned by short-term employees, in any case, are quite small. On the other hand, the committee believes that overly restrictive age and service eligibility requirements can arbitrarily 1 As described below (B.2. Plans Where a Collective Bargaining Unit is Involved; Other Anti-discrimination Provisions), a qualified plan must meet certain coverage standards. Several of the alternative standards require certain percentages of employees, or of eligible employees, to be covered by the plan, but in such cases the employer is permitted to exclude employees who fail to met the plan's service requirements, not exceeding five years of service. 2 An owner-employee is a sole proprietor or a partner with a greater than 10-percent interest in capiti or profits (sec. 401 (c) (3)). |