Retirement Plan Issues In Dealing With Employees On Active Military Duty

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1 Retirement Plan Issues In Dealing With Employees On Active Military Duty Pamela D. Perdue Serving Uncle Sam doesn t mean sacrificing employee benefits Pamela D. Perdue is of counsel to the St. Louis law firm of Summers, Compton & Wells, P.C. She serves as a member of the Editorial Advisory board to the Journal of Pension Planning & Compliance. She is the author of the book Qualified Pension and Profit-Sharing Plans published by Thomson Reuters. There are now a host of laws governing the provision of benefits to employees who must leave civilian employment to enter into active military service. These laws include provisions enacted as part of the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA) as well as changes made by the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART). In addition, the Pension Benefit Guaranty Corporation recently amended its benefit payment regulations to extend benefit guarantees to certain employees who are on military duty when the employer s pension plan is terminated in a distress or involuntary termination. Finally, retirement plans must also be mindful of the special rules that can come into play when a participant with an outstanding loan leaves for military service. Overview of USERRA The push to better protect the rights and benefits of civilian employees who must leave that employment to perform active military duty began with the enactment of USERRA, which revised and restated the Federal law protecting veterans reemployment rights. Essentially, USERRA provides that an individual who leaves his or her job to perform qualified The Practical Tax Lawyer 19

2 20 The Practical Tax Lawyer Summer 2010 military service is generally entitled to reemployment by the employee s previous employer provided the individual returns to employment within a specified period of time. In addition to reemployment rights, however, USERRA also provides for the restoration, upon reemployment, of certain pension, profit sharing, and similar benefits that would have accrued but for the employee s absence due to the qualified military service. Employers Covered Public And Private Employers Without Regard To Size Unlike some other labor laws which are applied only to employers of a certain minimum size, the scope of USERRA is quite broad, with coverage extending to virtually all employers without a threshold or minimum size limit. USERRA applies not only to private employers of all sizes, but also to the Federal government as well as to the States. [20 C.F.R (a)]. For this purpose, the term State includes the District of Columbia, the Commonwealth of Puerto Rico, Guam, the Virgin Islands, and other territories of the United States, including the agencies and political subdivisions thereof. 20 C.F.R (m). Foreign Employers USERRA applies to foreign employers doing business in the United States. A foreign employer that has a physical location or branch in the United States (including U.S. territories and possessions) must comply with USERRA for any of its employees who are employed in the United States. 20 C.F.R (b). American Companies In Foreign Countries An American company operating either directly or through an entity under its control in a foreign country must also comply with USERRA for all its foreign operations, unless compliance would violate the law of the foreign country in which the workplace is located. 20 C.F.R (c). What About Native American Tribes? The Department of Labor (DOL) believes that, while the face of the statute does not explicitly cover Native American tribal employers, USERRA s legislative history reflects that the Act was indeed intended to apply to Native American tribes and their business enterprises, citing S. Rep. No , at 42 (1993). However, although the DOL concludes in the Preamble to the Final Regulations that USERRA likely applies to Native American tribal employers, it also states that it recognizes that there is a difference between the right to demand compliance with the law and the means to enforce it, citing Kiowa Tribe of Oklahoma v. Manufacturing Techs., Inc., 523 U.S. 751, 754 (1998). This difficulty arises due to the general sovereign immunity from suit enjoyed by Native American tribes, except where Congress has authorized the suit or the tribe has waived its immunity. Service In The Uniformed Services While USERRA mandated certain changes, it failed to harmonize those changes with actual Internal Revenue Code provisions. Rather, it was left to the Small Business Job Protection Act of 1996 to amend the Code to add section 414(u). Code section 414(u) generally provides that covered plans must provide benefits for those who are entitled to the protections of chapter 43 of title 38, i.e., for those entitled to the protections of USERRA. USERRA provides protection and reemployment rights for those who perform service in the uniformed services. Service in the uniformed services is defined under the regulations to mean the performance of duty on a voluntary or involuntary basis in a uniformed service under competent authority. Service in the uniformed services includes active duty, ac-

3 Employees On Active Military Duty And Retirement Plan Issues 21 tive and inactive duty for training, National Guard duty under Federal statute, and a period for which a person is absent from a position of employment for an examination to determine the fitness of the person to perform such duty. The term also includes a period for which a person is absent from employment to perform funeral honors duty as authorized by law. See, 10 U.S.C or 32 U.S.C The Public Health Security and Bioterrorism Preparedness and Response Act of 2002, Pub. L. No , provides that service as an intermittent disaster-response appointee upon activation of the National Disaster Medical System (NDMS) or as a participant in an authorized training program is deemed service in the uniformed services. 20 C.F.R (l). Impact of USERRA on Retirement Plans Section 414(u) clearly applies to plans attempting to be tax qualified. However, the scope of USERRA coverage is much broader. Specifically, 20 C.F.R applies the benefits provisions of USERRA to a pension plan. The term pension plan is defined primarily with reference to ERISA. As such, USERRA applies to a pension plan as defined for purposes of ERISA, meaning an employee benefit plan that provides retirement income to employees, or defers employee income to a period extending to or beyond the termination of employment. ERISA section 3(2) (A). Any such plan maintained by the employer or employers is covered under USERRA. However, USERRA also covers certain pension plans not covered by ERISA, such as those sponsored by a State, government entity, or church for its employees. USERRA does not, however, cover pension benefits under the Federal Thrift Savings Plan; those benefits are covered under 5 U.S.C. 8432b. 20 C.F.R Absence For Military Service Note that the time absent treated as military service is broader than merely the time actually performing qualified military service. Depending upon the length of the employee s period of service, he or she is entitled to take from one to 90 days following service before reporting back to work or applying for reemployment. See 20 C.F.R This period of time is required to be treated as continuous service with the employer for purposes of determining participation, vesting, and accrual of pension benefits under the plan. 20 C.F.R If the employee is hospitalized for, or convalescing from, an illness or injury incurred in, or aggravated during, service, he or she is entitled to report to or submit an application for reemployment at the end of the time period necessary for him or her to recover from the illness or injury. This period, which may not exceed two years from the date the employee completed service, except in circumstances beyond his or her control, must be treated as continuous service with the employer for purposes of determining the participation, vesting, and accrual of pension benefits under the plan. 20 C.F.R Under the revisions to both 20 C.F.R and , the entire period of absence from work due to or necessitated by service in the uniformed services, including preparation time and recuperation time, is to be considered service with the employer upon reemployment for computation of seniority and seniority-based rights, including pension entitlements. Preamble to final USERRA Regulations. USERRA Changes Applicable To Covered Plans USERRA made changes to retirement plans in four areas: (1) vesting, (2) eligibility, (3) benefit accrual and (4) contributions.

4 22 The Practical Tax Lawyer Summer 2010 While not originally enacted as part of USER- RA, ultimately Code section 414(u) was enacted to implement those provisions of USERRA required to be implemented in retirement plans. Break In Service Eligibility And Vesting For purposes of both eligibility and vesting, an individual who is reemployed and is subject to reemployment under USERRA is not treated as having incurred a break in service by reason of the qualified military service. IRC 414(u)(8). Note that the break in service rule as reflected in section 414(u)(8) on its face is not clear that it applies for purposes of eligibility as well as for purposes of vesting. However, this is the interpretation of the DOL as reflected in its Preamble to the final USERRA regulations. The Department received two comments regarding section , which establishes the general principle that upon reemployment, an employee must be treated as not having a break in service with the employer for the purposes of participation, vesting and accrual of pension benefits. Both comments requested that the provision be broadened to include an employee s eligibility for pension benefits. The phrase participation, vesting and accrual includes an employee s eligibility for pension benefits, and therefore no modification is needed in response to the commenters suggestions. 70 Fed. Reg. 75,280 (2005) In addition, it appears that the term break in service is not being used in its more typical technical manner used under the Code, but rather, appears to be interchangeable with the phrase continuous service. This is the exchange at Q7 of the DOL s FAQ for Reservists Called to Active Duty: Q7: Will my period of active duty be considered a break in service with my employer and impact my eligibility to participate in my employer s retirement plan or my vesting or benefit accrual under the plan? No. USERRA requires that the period of military duty be counted as covered service with the employer for eligibility, vesting, and benefit accrual purposes. Returning service members are treated as if they had been continuously employed regardless of the type of retirement plan the employer has adopted. However, a person who is reemployed is entitled to accrued benefits resulting from employee contributions only to the extent that he or she actually makes the contributions to the plan. FAQ-Reservists Called to Active Duty; gov/ebsa/faqs/faq_911_2.html. Example: A recently hired employee leaves employment for active military duty after only two months of employment. The plan requires one year of service for eligibility. During the three years that the employee is gone, the plan is amended to add an automatic enrollment provision. During the period of military service, the employee is deemed to have satisfied the plan s eligibility requirements. However, despite the automatic enrollment feature, neither the employee s contribution obligations nor the employer s arise until the employee returns to employment from active duty. Qualified Military Service = Vesting Service Moreover, as a further expansion of the vesting rules, upon reemployment, each period of qualified military service is deemed to constitute service with the employer for vesting purposes. Code 414(u)(8). Benefit Accrual And Contributions Similarly, also upon reemployment, each period of qualified military service is also deemed to constitute service with the employer for benefit accrual purposes. IRC 414(u)(8). With the exception of multiemployer plans, which have separate rules that are discussed below, the employer is liable to the pension benefit plan to fund any obligation of the plan to provide benefits that are attributable to the employee s period of service. In the case of a defined contribution plan, once the employee is reemployed, the employer must allocate (if any) the amount of its make-up contribution for the employee, his or her make-up employee

5 Employees On Active Military Duty And Retirement Plan Issues 23 contributions, and his or her elective deferrals, in the same manner and to the same extent that it allocates the amounts for other employees during the period of service. This means that the contribution must be allocated using the plan s terms and formula for the years to which the contribution relates. Code 414(u)(2)(A)(ii); 20 C.F.R Example: Assume a participant returns to a money purchase plan from covered military service. During the period of military service, the plan provided for and the employer allocated a contribution of 10 percent of each eligible employee s compensation. This means that the employee, upon reemployment, is also entitled to receive an employer contribution of 10 percent of his/her USERRA determined compensation. Example: What if, instead of a money purchase plan in the prior example, the employer maintained a profit sharing plan with a discretionary contribution, where if a contribution is made, the contribution is allocated in the same ratio that each eligible employee s compensation bears to the total compensation? Had the employee remained actively employed during that year, the base compensation, or total compensation figure, would obviously have been different and the level of the employer s contribution ultimately as a percentage of each employee s compensation might have been different as well. While speculative, the goal is in fact to reproduce the contribution that would have been made absent the military service. However, the regulations, in discussing the laws application to multiemployer defined contribution plans, suggest a Congressional history to prohibit reductions of participants account balances to fund the obligation for the returning participant under USERRA. Reallocating by redetermining the percentage allocation including the returning participant s compensation would seem to run afoul of that position. As such, the better option would appear to be to allocate whatever percentage was actually applied to the active participants to that of the returning service member based upon the service member s USERRA compensation. In the case of a defined benefit plan, the employee s accrued benefit will be increased for the period of service once he or she is reemployed and, if applicable, has repaid any amounts previously paid to him or her from the plan and made any employee contributions that may be required to be made under the plan. 20 C.F.R When Must Make Up Contributions Be Made? Employee Must First Be Reemployed With respect to the issue as to when the contribution must be made, as a threshold matter, it must be remembered that the employer is not required to make its contribution until the employee is reemployed. Employer Non-Contingent Make Up Contributions For employer contributions to a plan in which the employee is not required or permitted to contribute, the employer is required to make the contribution attributable to the employee s period of service no later than 90 days after the date of reemployment, or when plan contributions are normally due for the year in which the service in the uniformed services was performed, whichever is later. If it is impossible or unreasonable for the employer to make the contribution within this time period, the employer must make the contribution as soon as practicable. 20 C.F.R (a). However, in its FAQ, the IRS provides a different response. Essentially, the IRS has stated informally that the employer has the same time period for making up non-contingent employer contributions as applies to the employee making up his/her contributions, i.e., the three times the period of qualified service not to exceed five years time period. IRS FAQs regarding USERRA and

6 24 The Practical Tax Lawyer Summer 2010 SSCRA (Soldiers and Sailors Civil Relief Act), 4th question listed under Employer Contributions, 0,,id=109878,00.html. How is an employer to resolve this conflict? For two reasons, the better course would be to comply with the 90-day rule. First, the Preamble to the DOL regulations states that, while the DOL can, of course, only provide guidance with respect to its own regulatory requirements, both the IRS and the Treasury have indicated that a health or pension plan will be deemed not to be in conflict with the applicable IRC requirements merely because of compliance with USERRA or its regulations. Preamble to DOL regulations, Section B: Compliance With USERRA and Compliance With the Internal Revenue Code, available at 70 Fed. Reg. at 75,247. Thus, complying with the 90-day rule will not cause a plan to run afoul of the Code requirements. Further, in most instances, compliance with the 90-day rule is likely to result in the employer s contribution being made earlier than had it followed the IRS s informal guidance. Employee Make Up Contributions If the employee is enrolled in a contributory plan, the employee is allowed (but not required) to make up his or her missed contributions or elective deferrals. The makeup contributions or elective deferrals must be made during a time period starting with the date of reemployment and continuing for up to three times the length of the employee s immediate past period of uniformed service, with the repayment period not to exceed five years. Makeup contributions or elective deferrals may only be made during this period and while the employee is employed with the post-service employer. 20 C.F.R (b); IRC 414(u)(2)(A)(i). The employee is not required to make up the full amount of employee contributions or elective deferrals that he or she missed making during the period of service. 20 C.F.R (d). When an employee is gone for more than one plan year, IRS informal guidance states that the employee gets to designate the specific year(s) that his/her contributions cover. IRS FAQs regarding USERRA and SSCRA, 4th question listed under Employee Contributions, How is the employee on active duty to be treated for purposes of the ADP test? That is, is the employee added in at 0 percent for the year of service or is the employee only included in the actual year of the employee s return? The answer appears to be neither. That is, the regulations provide that additional elective contributions made pursuant to section 414(u) by reason of an eligible employee s qualified military service are not taken into account under paragraph (a)(4) (that is, under Treas. Reg (k)-2(a)(4) describing the elective contributions to be taken into account) for the plan year for which the contributions are made, or for any other plan year. Treas. Reg (k)-2(a)(5)(v). The Preamble to the regulations likens the treatment of these contributions to the treatment of catch-up contributions under section 414(v). What if the employer has continued to pay the employee differential wages during the period of his or her service? Is the plan allowed to take the elective deferrals into account for nondiscrimination purposes? According to the IRS, the plan is permitted, but not required to do so. Specifically, in Notice , in response to the question as to whether contributions and benefits provided as a result of differential wage payments may be included in the plan s nondiscrimination testing, the IRS states that a plan may exclude such contributions and benefits from the nondiscrimination testing. That is, in accordance with Code section 414(u)(12)(A), a plan is not treated as failing to meet the requirements of any nondiscrimination provision described in section 414(u)(1)(C) (i.e., 401(a)(4), 401(a)(26), 401(k) (3), 401(k)(11), 401(k)(12), 401(m), 403(b)(12), 408(k)

7 Employees On Active Military Duty And Retirement Plan Issues 25 (3), 408(k)(6), 408(p), 410(b) or 416) by reason of any contribution or benefit based on a differential wage payment, as long as the differential wage payment and the ability to make contributions based on the differential wage payment are provided on reasonably equivalent terms. Accordingly, the contributions and benefits provided under a plan as a result of differential wage payments need not be included in the plan s nondiscrimination testing. On the other hand, section 414(u)(1)(C) does not prevent such contributions and benefits from being taken into account, as long as they do not cause the plan to fail the nondiscrimination requirements. If such contributions and benefits are included in the plan s nondiscrimination testing for any employee, they must be taken into account for all employees. Notice , Q & A 17. If the employee was not contributing before the military service, must the employee still be allowed to make up contributions upon return to service? This is a question that is not addressed in any guidance. The logical answer would suggest that if the employee had previously decided not to contribute, there should be no need to provide make-up rights. However, nothing in USERRA explicitly addresses this issue or limits the right to make up contributions to those who had elected before active military service to make contributions. Most employers will likely wish to extend the offer to the employee on return to service without regard to the employee s elections before active duty. Further, the employer may well wish to make sure that the plan s language will accommodate a special election upon return to service. Could the plan simply continue deferral elections? Possibly, if the employee is making differential pay. This is because the amendment to the section 415 regulations defining compensation specifically provides for the inclusion of military differential pay as section 415 compensation. Specifically, the regulations provide an exception from the general rule that amounts must be paid before severance from employment to constitute compensation for purposes of section 415 for payments to an individual who does not currently perform services for the employer by reason of qualified military service (as that term is used in section 414(u)(1)) to the extent those payments do not exceed the amounts the individual would have received if the individual had continued to perform services for the employer rather than entering qualified military service, provided the plan so provides. Treas. Reg (c)- 2(e)(4). Moreover, post HEART Act, differential wages are required to be included in the definition of compensation for purposes of section 415. Notice , Q & A 9. Employer Matching And Other Contingent Contributions Because a matching contribution is contingent on the employee making his/her contribution, if the employee s plan is contributory and the employee, upon reemployment, does not make up his or her contributions or elective deferrals, the employee will not receive the employer match or the accrued benefit attributable to his or her contribution. USERRA does not specify when matching contributions are required to be made. Rather, the regulations provide that any employer contributions that are contingent on or attributable to the employee s make-up contributions or elective deferrals must be made according to the plan s requirements for employer matching contributions. 20 C.F.R (c). Informally, in its Newsletter, the Service states that the employer matching contributions must occur as soon as the rehired veteran pays in the missed elective contribution. IRS Employee Plans News, Winter, available at irs-tege/wino4.pdf. In its FAQs (4th question listed under Employer Contributions ), however, the IRS states that :

8 26 The Practical Tax Lawyer Summer 2010 [T]he employer does not have to begin the makeup contributions until after the veteran returns to civilian employment with the same employer. The employer s makeup contribution period is equal to three times the period of qualified military service - not to exceed five years. If the employer contributions were contingent on the employee making elective contributions and the employee makes up the missed contributions, the employer must make up its contributions over the same period the veteran uses to pay the makeup deferrals. html May Or Must The Employee Make Up Missed Earnings? No. The employee is neither required nor permitted to make up missed earnings. This is because, under the regulations, the employee is neither required nor permitted to make up a missed contribution in an amount that exceeds the amount he or she would have been permitted or required to contribute had the employee remained continuously employed during the period of service. Similarly, the plan is not required to allocate earnings with respect to any missed employer contribution. Code 414(u)(3)(A); 20 C.F.R Is The Employee Required To Share In Forfeitures Upon Reemployment? No. The law does not require an allocation of forfeitures with respect to the period of qualified military service. Code 414(u)(3)(B). What Happens To The Employee s Repayment Rights (And The Employer s Contribution Obligations) In The Event Of Plan Termination? This is another question without any explicit guidance. A defined contribution plan sponsor may well desire to terminate the plan at a time when there are outstanding potential rehire contribution and repayment rights either because employees have not yet returned from active duty or because the repayment time period has not yet expired. One approach advanced in the case of a purely non-contingent employer contribution may well be to take the position that USERRA mandates that the employer make its contribution upon the employee s reemployment but does not preclude the employer from being more liberal or generous. That is, when the plan is non-contributory, the employer could simply take the position that it will go ahead and make the attributable contribution based upon the employee s projected USERRA compensation, even before the employee s reemployment. However, it must be remembered that this approach is without any explicitly support in the Code and could be viewed as making contributions not supported under the Code. Repayment Of Withdrawn Defined Benefit Upon reemployment, a participant in a defined benefit plan must be allowed to repay any withdrawn benefit distributed in connection with his or her service in the uniformed services before he or she became reemployed. Here, the amount the employee must repay includes any interest that would have accrued had the benefit not been withdrawn. The employee must be allowed to repay these amounts during a time period starting with the date of reemployment and continuing for up to three times the length of the employee s immediate past period of uniformed service, with the repayment period not to exceed five years (or such longer time as may be agreed to between the employer and the employee), provided the employee is employed with the post-service employer during this period. 20 C.F.R Determining Compensation The general rule is that where the employee s rate of compensation must be calculated to determine pension entitlement, the calculation must be made using the rate of pay that the employee would have received but for the period of uniformed service.

9 Employees On Active Military Duty And Retirement Plan Issues 27 Example: Assume that an employee leaves employment during the third month of a plan year. The employee is salaried and was making $36,000 for a 12-month period. The employee was not paid differential pay and therefore, during the plan year, only received compensation from the employer of $9,000. When the employee returns from active duty two years later, the employer should assume that the employee earned $36,000 during the year in which he left employment. Example: Assume the same facts as above except that during that first year, all employees in the service member s job description received a cost of living increase. Should the employer assume the same for the employee upon return to active duty? Not entirely clear, but the most likely answer is that the cost of living increase should be assumed for the year in which the employee left to perform military service. When the rate of pay the employee would have received is not reasonably certain, such as when compensation is based on commissions earned, the average rate of compensation during the 12-month period before the period of uniformed service must be used. When the rate of pay the employee would have received is not reasonably certain and he or she was employed for fewer than 12 months before the period of uniformed service, the average rate of compensation must be derived from this shorter period of employment that preceded service. Code 414(u)(7). Special Rules For Multiemployer Pension Plans In addition to the other provisions of USERRA that apply to all pension benefit plans, the following special rules apply to multiemployer plans: The last employer that employed the employee before the period of service is responsible for making the employer contribution to the multiemployer plan, if the plan sponsor does not provide otherwise. If the last employer is no longer functional, the plan must nevertheless provide coverage to the employee. An employer that contributes to a multiemployer plan and that reemploys the employee pursuant to USERRA must provide written notice of reemployment to the plan administrator within 30 days after the date of reemployment. The returning service member should notify the reemploying employer that he or she has been reemployed pursuant to USERRA. The 30-day period within which the reemploying employer must provide written notice to the multiemployer plan pursuant to this subsection does not begin until the employer has knowledge that the employee was reemployed pursuant to USERRA. The employee is entitled to the same employer contribution whether he or she is reemployed by the pre-service employer or by a different employer contributing to the same multiemployer plan, provided that the pre-service employer and the post-service employer share a common means or practice of hiring the employee, such as common participation in a union hiring hall. 20 C.F.R The Preamble makes clear that an individual s period of uniformed service that qualifies as employment for purposes of 38 U.S.C. 4318(a)(2) is also employment under the terms of the pension benefit plan, any applicable collective bargaining agreement under 29 U.S.C. 1145, or any similar Federal or State law requiring employers who contribute to multiemployer plans to make contributions as specified in plan documents. In the case of a multiemployer plan, a service member does not have to be reemployed by the same employer

10 28 The Practical Tax Lawyer Summer 2010 for whom he or she worked before the period of service to be reinstated in the pension plan. The third bullet above reflects a revised approach from the proposed regulations. The previously proposed regulations took the position that so long as the post-service employer is a contributing employer to the plan, the service member is entitled to be treated as though he or she experienced no break in service under the plan. Commentators suggest that this should only be the case where the pre- and post-service employers would be required to be otherwise related by a common job referral or hiring scheme beyond their common participation in the plan. The DOL then reviewed the applicable legislative history. The DOL concluded that this legislative history suggests that mere participation by different pre- and post-service employers in a common multiemployer plan is not enough to invoke pension liability for service-related absences. Accordingly, the DOL has amended section (c) to reflect that when an employee is reemployed by an employer that is different from his or her pre-service employer, and the pre- and post-service employer contribute to the same multiemployer pension plan, the two employers must be connected by a common job referral plan or practice for USERRA s pension obligations to attach to the post-service employer. See 20 C.F.R (c). With respect to the allocation of the employer s contribution upon reemployment, section describes that initially, the benefits liability is to be allocated as specified by the sponsor maintaining the plan. 38 U.S.C. 4318(b)(1)(A). As this will likely be a function of bargaining, the regulations recognize that the allocation is likely to vary from plan to plan. However, if the plan documents make no provision to allocate the obligation to contribute, then the individual s last employer before the service period is liable for the employer contributions. If that entity no longer exists or functions, the plan must nevertheless provide coverage to the service member. 38 U.S.C. 4318(b)(1)(B). The final regulations revised 20 C.F.R (b) to provide that the 30-day period within which notice to the plan must be made does not begin until the reemploying employer has knowledge that the employee was reemployed under USERRA. In addition, the amended provision further states that the returning service member should notify the employer upon reemployment that he or she has been reemployed following a period of military service. What Should Plan Do About The Investment Of The Participant s Account? When a participant is leaving for a possible extended military leave, plans will likely need to prepare for what will happen with respect to the investment of the participant s account. Plans may wish to allow the participant to designate a relative or advisor or someone else who will be able to make investment decisions and exercise investment elections under the plan during what may be an extended absence. Clarifications And Limitations Of Section 414(u) In addition to mandating the provision of benefits to those employees covered by USERRA, section 414(u) also provides clarifications designed to ensure that plans can comply with the provisions of USERRA without running afoul of other Code provisions. It is section 414(u) that contains the provisions of USERRA allowing for make-up contributions. In addition, section 414(u) provides that compliance with USERRA, with respect to such things as make-up contributions, will not cause the plan to run afoul of other Code sections, specifically, sections 401(a)(4), 401(a)(26), 401(k)(3), 401(k) (11), 401(k)(12), 401(m), 403(b)(12), 408(k)(3), 408(k) (6), 408(p), 410(b) or 416. Code 414(u)(1)(C). For these purposes, such make-up contributions are not

11 Employees On Active Military Duty And Retirement Plan Issues 29 counted either for the year of the contribution or for the year to which the contribution relates. Small Business Job Protection Act of 1996 Pub. L. No , H.R. Rep. No Further, so that make-up contributions will not cause the plan to violate any of the various plan limits, section 414(u)(1)(A) provides that such contributions shall not be treated as subject to any otherwise applicable limitation contained in sections 402(g), 402(h), 403(b), 404(a), 404(h), 408, 415, or 457, and shall not be taken into account in applying such limitations with respect to the year in which the contribution is made. Rather, such contributions are to be subject to the limitations with respect to the year in which the contribution relates. IRC 414(u)(1)(B). Changes Resulting from the HEART Act USERRA generally provides benefits for reemployed veterans, mandating that, upon reemployment, service in the uniformed services is considered service with the employer for retirement plan vesting and benefit accrual purposes. The HEART Act, on the other hand, is designed to address the provision of benefits to those who are unable to return to service. In general, a plan must be amended to comply with the provisions of the HEART Act on or before the last day of the plan year beginning on or after January 1, Death Benefits Mandatory The HEART Act adds a new qualification requirement governing the provision of death benefits. A tax qualified plan must provide that, in the case of a participant who dies while performing qualified military service, the survivors of the participant must be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would be provided under the plan had the participant resumed employment with the employer maintaining the plan and then terminated employment on account of death. IRC 401(a)(37). This means, for example, if a plan provides for accelerated vesting, ancillary life insurance benefits, or other survivor benefits that are contingent upon a participant s termination of employment on account of death, the plan must provide such benefits to the beneficiary of a participant who dies during qualified military service. Similar changes were made to sections 403(b) and 457(b) with respect to arrangements maintained by governmental entities. Code 403(b)(14) and 457(g)(4). It also means that the plan must in all events grant vesting credit for the period of military service. This is because had the employee actually returned to employment on the day prior to his/her actual death, in accordance with USERRA, the plan would have been required to grant credit for vesting service. Notice Q & A 3. The provision applies in the case of deaths occurring on or after January 1, Treatment Of Differential Wage Payments And Continued Employee Status Compensation Provisions At Least Now Considered Discretionary Differential Pay As Wages Before the enactment of the HEART Act, differential pay, that is, amounts paid by employers to make up the difference between what the employee would receive as a continued active employee and what the employee would receive while on active military duty, did not constitute wages for income tax withholding purposes. This is because the employment relationship was deemed to be terminated upon the employee being called to active duty. See Rev. Rul , C.B This meant then that differential pay paid to those in active military service could not be used to fund elective contributions nor employer contributions, because differential pay did not constitute

12 30 The Practical Tax Lawyer Summer 2010 compensation either for purposes of most plans definitions nor, more importantly, for purposes of section 415. Thus, even if treated as compensation for purposes of the plan s definition, use of differential pay to fund, for example, elective contributions would result in a section 415 violation absent other compensation from the employer for the limitation year. To address this issue, the revised final section 415 regulations issued in 2007 generally permit, but do not require, a plan to treat differential pay as compensation for purposes of section 415. Treas. Reg (c)-2(e)(4), 72 Fed. Reg. 16,878 (Apr. 5, 2007). The HEART Act takes this approach one step further by amending the definition of wages for purposes of the Federal income tax withholding rules to include differential pay. Specifically, as amended, the definition of wages includes the employer s payment of any differential wage payment to the employee. Differential wage payment is defined as any payment which: (1) is made by an employer to an individual with respect to any period during which the individual is performing service in the uniformed services while on active duty for a period of more than 30 days; and (2) represents all or a portion of the wages that the individual would have received from the employer if the individual were performing services for the employer. Code 3401(h)(2). Specifically, the governing statute provides as follows: (A) In general. Except as provided in this paragraph, for purposes of applying this title to a retirement plan to which this subsection applies (i) an individual receiving a differential wage payment shall be treated as an employee of the employer making the payment, (ii) the differential wage payment shall be treated as compensation, and (iii) the plan shall not be treated as failing to meet the requirements of any provision described in paragraph (1)(C) by reason of any contribution or benefit which is based on the differential wage payment. IRC 414(u)(12)(A). However, notwithstanding the language of the statute which appears to be mandatory, the IRS has taken the position that the mandatory nature of the language applies solely for purposes of the definition of compensation for Code purposes, e.g., for purposes of section 415. However, a plan s definition of compensation is not required to include differential wages. Moreover, the failure to include differential wages will not cause the plan s definition of compensation to fail to constitute a safe harbor definition under section 414(s). Notice , Qs & As 9 & 10. Retention Of Employee Status Moreover, the HEART Act also amended section 414(u) to provide that an individual receiving a differential wage payment is still treated as an employee of the employer making the payment. Code 414(u)(12)(A). Satisfaction Of Nondiscrimination Requirements Section 414(u)(12)(B) further provides that a plan is not treated as failing to meet the various nondiscrimination and other requirements set forth in section 414(u)(1)(C) (including nondiscrimination, minimum participation, coverage, top heavy and other requirements) by reason of any contribution or benefit that is based on the differential wage payment provided that all employees of an employer (as determined after applying the aggregation rules of sections 414(b), (c), (m) and (o)) performing services in the uniformed services described in section 3401(h)(2)(A): (1) are entitled to receive differential wage payments on reasonably equivalent terms, and (2) if eligible to participate in a retirement plan maintained by the employer, are entitled to make contributions based on such differential

13 Employees On Active Military Duty And Retirement Plan Issues 31 payments on reasonably equivalent terms. Code 414(u)(12)(C). Note, however, that a plan is not precluded from taking attributable contributions and benefits into account for the various nondiscrimination tests listed in the statute if it helps the plan. If such contributions and benefits are included in the plan s nondiscrimination testing for any employee, they must be taken into account for all employees. Notice , Q & A 17. Effective Date For purposes of the wage withholding rules, the provision is effective with respect to remuneration paid after December 31, Otherwise, the provision is effective with respect to years beginning after December 31, Death And Disability Benefits Discretionary USERRA provides additional benefits for those service members who are reemployed by their former employers. However, no additional service, for vesting purposes or otherwise, applies when the individual cannot be reemployed. The HEART Act permits but does not require an employer, for benefit accrual purposes, to treat an individual who dies or becomes disabled (as defined under the terms of the plan) while performing qualified military service with respect to the employer maintaining the plan, as if the individual has resumed employment in accordance with the individual s reemployment rights under chapter 43 of title 38, United States Code, on the day preceding death or disability (as the case may be) and terminated employment on the actual date of death or disability. For such a deemed rehired employee, the plan is permitted to comply fully or partially with the benefit accrual restoration provisions that would be required under section 414(u) had the individual actually been rehired. Code 414(u)(9). Subject to several conditions, if a plan complies fully or partially with these benefit accrual requirements, the special section 414(u) rules regarding the interaction of USERRA with the otherwise applicable benefit limitation and nondiscrimination rules apply. The first condition is that all employees of the employer maintaining the plan (as determined under sections 414(b), (c), (m) and (o)) who die or become disabled as a result of performing qualified military service before reemployment must be credited with service and benefits on a reasonably equivalent basis. Code 414(u)(9)(B). According to the Joint Committee Explanation, differences in credited benefits on account of different compensation levels are permissible, but complying fully with the section 414(u) benefit accrual requirements with respect to highly compensated employees and complying partially with respect to nonhighly compensated employees is not permissible. [Joint committee Summary and Explanation of Pub. L. No , Heroes Earnings Assistance and Relief Tax Act of 2008] Committee Report for JCS-1-09, JCS-1-09, General Explanation on Tax Legislation Enacted in the 110 th Congress (Blue Book). The second condition is that if the plan credits deemed rehired employees with benefits that are contingent on employee contributions or elective contributions, the plan must determine the rate of employee contributions or elective deferrals on the basis of the actual average contributions or deferrals made by the employee during the 12-month period before military service (or if less than 12 months, the average for the actual period of service). Code 414(u)(9)(C). The provision applies in the case of deaths and disabilities occurring on or after January 1, In-Service Distributions Discretionary Most distributions from qualified plans cannot be made while the participant remains in service.

14 32 The Practical Tax Lawyer Summer 2010 Notwithstanding the fact that an individual receiving differential pay is treated as an employee of the employer making the payments, the HEART Act provides that, for purposes of section 401(k)(2) (B)(i)(I), 403(b)(7)(A)(ii), 403(b)(11)(A) or 457(d)(1)(A) (ii), an individual shall be treated as having been severed from employment during any period the individual is performing service in the uniformed services while on active duty for a period of more than 30 days. Code 414(u)(12)(B)(i). Thus, such individuals are not prohibited from receiving distributions on account of not severing employment. However, if an individual elects to receive a distribution by reason of this rule, the plan must provide that the individual may not make an elective deferral or employee contribution during the six-month period beginning on the date of the distribution. Code 414(u)(12)(B)(ii). Notice clarifies this provision in two ways. First, notwithstanding the language of the statute which could be read to limit its application solely to those receiving differential pay, Notice states instead that section 414(u)(12)(B) applies to all individuals on active duty for a period of more than 30 days, without regard to whether they are receiving differential wage payments. Notice , Q & A11. Second, the Notice states that this provision is discretionary. Plans are not required to provide for these deemed distributions. Specifically, Notice states at Q & A 12 that, just as a plan may, but is not required to, provide for distributions under sections 401(k), 403(b), or 457(d) upon actual severance from employment, a plan may, but is not required to, provide for distributions upon a deemed severance from employment under section 414(u)(12)(B). Thus, for example, a plan that provides for distributions upon severance from employment may, but is not required to, also provide for distributions upon a deemed severance from employment under Section 414(u)(12)(B). If a plan does, however, provide for these deemed distributions, it must also provide that an individual receiving the distribution may not make an elective deferral or employee contribution during the six-month period beginning on the date of the distribution. Note, however, that merely because an individual is treated as having incurred a deemed distribution for this purpose, this does not cause the individual to be treated as severed from employment under sections of the Code other than sections 401(k)(2)(B)(i)(l), 403(b)(7)(A)(ii), 403(b)(11)(A), and 457(d)(1)(A)(ii). Notice , Q & A 13. Note, however, that an actual severance from employment would trump the deemed severance rules. Thus, for example, if an individual has an actual severance from employment, is on active status for more than 30 days, receives a distribution, and returns to employment within six months, section 414(u)(12)(B)(ii) would not preclude the individual from making elective deferrals before the end of the six-month period. Notice , Q & A 14. Exception From 10% Excise Tax Made Permanent Generally, taxable distributions before age 59½, death, or disability, are subject not only to income inclusion, but a 10 percent early distributions excise tax as well. Code 72(t). Pursuant to amendments made by the Pension Protection Act of 2006, Pub. L. No , the excise tax does not apply, however, to a qualified reservist distribution. A qualified reservist distribution is a distribution (1) from an IRA or attributable to elective deferrals under a section 401(k) plan, a section 403(b) annuity, or certain similar arrangements, (2) made to an individual who (by reason of being a member of a reserve component as defined in section 101 of title 37 of the United States Code) was ordered or called to active duty for a period in excess of 179 days or for an indefinite period, and (3) that is made during the period beginning on the date of such order or call to duty and ending at the close of the active duty period.