[39] lieu of an increase in such compensation are to be considered to have been contributed by the employee and consequently be taxable income to the employee.1 The proposed regulations dealing with salary reduction plans raise major issues of tax policy. The basic question is the extent to which employees should be allowed to convert what would otherwise be a nondeductible employee contribution to a retirement plan to tax-deferred employer contributions on their behalf. This, in turn, involves issues regarding the equitable treatment under the tax laws of employee contributions and employer contributions to qualified retirement plans. In view of these basic issues, your committee has concluded that it would be desirable for the Internal Revenue Service to defer action on its regulations until the Congress has had further opportunity to consider this matter. For this reason, the bill directs the Secretary of the Treasury to withdraw the proposed salary reduction regulations issued on December 6, 1972. Moreover, no other salary reduction regulations may be issued in proposed form before January 1, 1975, or in final form before March 16, 1975. The bill further specifies that until new salary reduction regulations have been issued in final form, the law with regard to salary reduction plans is to be administered along the lines of the administration before January 1, 1972. Any salary reduction regulations which become final after March 15, 1975, for purposes of individual income tax, are not to take effect before January 1, 1975. Labor unions providing pension benefits. Your committee considered a provision recognizing the right of tax-exempt labor unions to provide pension benefits to its members from funds derived from members' contributions and the earnings on the contributions, without affecting their tax-exempt status. However, the committee concluded that labor unions are permitted to provide benefits in this manner under present law and as a result it decided such a provision is unnecessary. The Internal Revenue Service has recognized this result in a published ruling which provides "that payment by a labor organization of death, sick, accident or similar benefits to its individual members with funds contributed by its members, if made under a plan which has as its object the betterment of the conditions of the members does not preclude exemption of the organization under section 501(c) (5) of the code." 15 III. REVENUE EFFECT There are several kinds of revenue effects which can be expected to arise from H.R. 12855. These are summarized in table 4. 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 employee 14 This ruling did not affect annuities provided employees of tax-exempt charitable, educational and religious organizations and employees of public educational institutions under section 403(b) of the Internal Revenue Code. 15 Revenue Ruling 62-17, 1962-1, Cum. Bull. $7. [40] retirement savings deductions for those not now covered under qualified retirement plans, government plans, or section 403 (b) plans; and a provision which limits the maximum retirement benefit and the maximum deductible contribution on behalf of employees. Tax revenues are also affected by the modification of the tax treatment of lump-sum distributions. Finally, a third category of revenue effect from the bill arises not because of any change in tax deductions as such, but rather because increased amounts may be set aside by employees 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. These new requirements may result in employers making larger contributions to retirement plans, resulting in larger income tax deductions. [41] TABLE 4.-Estimated annual revenue effect of H.R. 12855 at 1973 levels of income and employment I. Provisions designed to equalize tax treatment under pension plans: 3 Total, provisions designed to equalize tax treatment under pen- Millions -$175 -355 +10 -520 II. Revised tax treatment of lump-sum distributions from retirement +60 III. Revenue effect of minimum vesting provision." Case 1: Assuming that the additional employer contributions to pen- -130 -265 0 Case 3: Assuming that benefit levels of pension plans are adjusted downward to absorb the additional employer contributions to pension plans resulting from the minimum vesting requirement------NOTE. There will be some revenue loss from funding but data are not available to determine the extent of this loss. 1 Maximum deductible amounts effective for taxable years beginning after Dec. 31, 1973; other provisions effective for taxable years beginning after Dec. 31,1975. 2 Maximum deductible amounts effective for taxable years beginning after Dec. 31, 1973; other provisions effective on Jan. 1, 1974. Apart from the exception for certain active participants in corporate defined benefit plans on Oct. 2, 1973, effective for contributions made or benefits accrued in years beginning after Dec. 31, 1975. Effective for distributions or payments made in taxable years beginning after Dec. 31, 1973. 5 Effective for plan years beginning after the date of enactment for plans adopted after Jan. 1, 1974. Effective for plan years beginning after Dec. 31, 1975, for plans in existence on Jan. 1, 1974, except: (1) for plans under collective bargaining agreements, effective for plan years beginning after the agreement termination date (but not before Dec. 31, 1975) of the last agreement relating to the plan or Dec. 31, 1980, whichever is earlier; (2) for labor organization plans, effective for plan years beginning after the date of the second convention of the organization (but not earlier than Dec. 31, 1975) held after the date of enactment or Dec. 31, 1980, whichever is earlier; and (3) where the plan administrator elects, effective for plan years beginning after the date of enactment but before the latest date available to each of the above categories of existing plans, respectively. Provisions designed to equalize tax treatment of retirement plans.— It is estimated that the provision increasing the maximum annual deductible pension contribution by self-employed persons on their own behalf to the greater of $750 (but not in excess of earned income) or 15 percent of earned income (up to $7,500) will result in an annual revenue loss of $175 million. [42] The provision allowing an individual not covered by a qualified retirement plan, government plan, or section 403(b) plan to deduct annually the lesser of $1,500 or 20 percent of compensation for contributions by him or on his behalf to a tax exempt retirement account, annuity, or bond plan established by him (or to certain trusts established by employers or associations of employers) is estimated to involve a revenue loss amounting to $225 million for 1974 and rising to $355 million for 1977 (at 1973 income levels). On the other hand, a revenue increase of $10 million a year at 1973 income levels is estimated to result from limiting the maximum annual benefit under defined benefit plans to the lesser of $75,000 (where benefits begin at age 55 or later) or 100 percent of average compensation for the three consecutive calendar years aggregating the highest compensation and limiting annual contributions under defined contribution plans to the lesser of $25,000 or 25 percent of compensation, with a cost-of-living adjustment to the dollar ceilings in the case of active participants and to the resultant amount under the 100 percent rule in the case of participants separated from service. Altogether, when fully effective, these three provisions involve an estimated annual net revenue loss of $520 million. Tax treatment of lump-sum distributions.-The revised tax treatment of lump-sum distributions from retirement plans (which provides for taxing that part of lump-sum distributions which is attributable to 1974 and later years as ordinary income subject to 10-year averaging) is expected to result in the long run in annual revenue gains amounting to $60 million a year based on 1973 levels of income. Revenue effect of minimum vesting and funding provisions.-The new minimum vesting standards, which generally become effective for plan years beginning after 1975, 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 the benefit levels of plans are adjusted 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 pension plans as a result of the vesting standards 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 standards constitute an [43] 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 that realistically there is likely to be a combination of the three effects suggested above. No revenue estimate is given for the increased funding requirements under the bill. Data are not available which would make a reliable 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. PARTICIPATION AND COVERAGE (Secs. 1011, 1015, 1017, 1021, and 1023 of the bill and Secs. 401, 410, and 414 of the Code). 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)). However, all plans may exclude part-time employees whose customary employment does not exceed 20 hours a week, and seasonal employees whose customary employment does not exceed five months in any calendar year. 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 num As described below (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 meet the plan's service requirements, not exceeding five years of service. An owner-employee is a sole proprietor or a partner with a greater than 10-percent interest in capital or profits (sec. 401 (c) (3)). |