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2023 Retirement Plan Limits Announced

The Internal Revenue Service announced new dollar limits for retirement plans for 2023, with most limits showing a sizeable increase over 2022 amounts. The new annual 401(k) elective deferral limit is $22,500 with a $7,500 catch up for those age 50 or older, permitting $30,000 to be contributed annually, or $5,000 per month. Plan sponsors should also note that the compensation threshold to determine highly compensated employees increases from $135,000, to $150,000, which is measured based on prior year’s compensation. The rest of the new limits are shown below:

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.

Photo credit: Rodion Kutsaiev, Unsplash

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IRS Announces 2022 Retirement Plan Limits

On November 4, 2021, the IRS announced 2022 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.  The maximum annual limit on salary deferral contributions to 401(k), 403(b), and 457(b) plans increased $1,000 to $20,500, but the catch-up contribution limit for employees aged 50 and older stayed the same at $6,500.  That raises the total deferral limit for a participant aged 50 or older to $27,000.  The Section 415(c) dollar limit for annual additions to a retirement account was increased to $61,000 from $58,000, and the $6,500 catch-up limit increases that to $67,500 for participants aged 50 or older.   In addition, the maximum limit on annual compensation under Section 401(a)(17) increased to $305,000 from $290,000, and the compensation threshold for Highly Compensated Employees increased to $135,000, from $130,000.  Other dollar limits that increased for 2021 are summarized below; citations are to the Internal Revenue Code.  Unchanged were the annual deductible IRA contribution and age 50 catch-up limit ($6,000 and $1,000, respectively), and the age 50 SIMPLE catch-up limit of $3,000.  In a separate announcement, the Social Security Taxable Wage Base for 2022 increased to $147,000 from the prior limit of $142,800 in 2021.

Photo credit: Atturi Jalli, Unsplash.

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Happy 10th Birthday, EforERISA

December 16, 2020 marks the 10th anniversary of our first post on this blog and this week EforERISA is debuting a fresh new look and redesign courtesy of Ashli Smith and her team at Spotted Monkey Marketing. We are always looking for ways to make this site better and more impactful so your constructive criticism and comments on the redesign are welcome. We also welcome suggestions on topics to cover in our future posts.

2021 promises to be a busy year on the benefits front, with a new administration in gear and light at the end of the tunnel for our economy as vaccination becomes more widespread. We look forward to keeping you posted on the benefits news you need to have, whether you are an employer sponsoring benefit plans for your employees, or a benefits broker or consultant for whom compliance is your stock in trade.

Photo Credit: Robert Anderson, Unsplash

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No Signature, No Shoes, No Service

As an ERISA attorney my heart sinks when I receive benefit plan documents from a client that are not properly signed and dated.  This happens not infrequently, although less often as time passes, due to the prevalence of electronic signatures.  Electronic signatures that comply with the federal ESIGN statute and comparable state statues are valid for ERISA documents, unless the plan document specifically requires manual signatures.

Signing an ERISA plan document or amendment is not a mere formality.  Rather, the tax-qualified status of the plan is contingent on properly executed plan documentation and could be revoked were the unsigned document revealed in an IRS audit.  This was made clear in a recent IRS Chief Counsel Memorandum that contradicts the holding in an earlier Tax Court Memorandum, Val Lanes Recreation Center Corporation v. Commissioner (T.C. Memo 2018-92 (2018)).  Each is summarized below, followed by some practical compliance steps.

The Val Lanes Case

In this case, the IRS revoked the tax-qualified status of an ESOP that had been set up by a business that operated a bowling alley in West Des Moines, Iowa.  The IRS selected the ESOP for audit in 2005.  It questioned several items, including the independence of the appraiser, who was the same CPA who set up the ESOP for Val Lanes.  But what the IRS finally tagged Val Lanes on was that it could not produce a signed copy of a USERRA plan amendment required under Section 414(u) of the Internal Revenue Code.  The Service requested the amendment during review of the ESOP’s request for a favorable determination letter, and conditioned the favorable letter upon timely adoption of the amendment.  The accountant prepared the amendment and sent it to Val Lanes’ principal, Mr. Essy, for signature.  He retained an unsigned copy, but neither he nor Mr. Essy could locate a copy of the signed amendment, and the Service revoked the qualified status of the ESOP.

In a declaratory judgment proceeding challenging disqualification, Mr. Essy testified that he always signed amendments and other plan documents that the accountant sent to him.  He also testified that the roof of the bowling alley failed in bad weather, resulting in extensive water damage to company records including those related to the ESOP.  The accountant testified to the best of his recollection that his client signed the necessary amendment.  Also relevant was that, in an unrelated matter, the IRS had seized computers and documents from the accountant’s home and offices and that the missing amendment might have been among the seized items.

The Tax Court found that the 414(u) amendment had been timely adopted despite absence of physical proof, pointing to the fact that Mr. Essy had signed a restated plan document, and to what it deemed to be a “credible explanation” as to why the signed copy was missing.  Thus, Val Lanes appears to create a “pattern and practice” doctrine that a plan sponsor could use as an alternative to producing a signed plan document or amendment. 

IRS Chief Counsel Memorandum

The Val Lanes decision raised concern among IRS benefits counsel and in 2019, the Office of Chief Counsel issued a Memorandum that basically limited the Val Lanes holding to the unusual facts of the case (flooding, seizure of accountant’s computers), and stated that it remains appropriate for IRS exam agents and others to pursue plan disqualification if an employer cannot produce a signed plan document.  (IRS Chief Counsel Memorandum AM 2019-002 (December 9, 2019)).  The Memorandum also clarified that the employer bears the burden of proof as to whether it executed a plan document as required, when it is unable to produce an executed plan or amendment. 

Practical Compliance Steps

The Memorandum is intended primarily for IRS internal use, however employers are wise to heed its message:  the “pattern and practice” argument that succeeded in the Val Lanes case simply is not available to employers in the ordinary course of events.  Rather, they must put in place, and consistently follow, procedures to ensure that plan documentation (including original plan documents, amendments and restatements) are timely signed and dated and must retain and be able to access electronic or other copies of the signed and dated originals.   Other compliance steps might include the following:

  • Take stock of all of your current benefit plans and make sure that you can locate signed and dated versions of all iterations of the plan document and all amendments.
  • If executed signature pages are missing, follow up with the plan recordkeeper, third party administrator, or other third party who prepared the document or amendment, to see if they have copies.
  • If copies cannot be located, determine whether it might be due to extraordinary events such as those in Val Lanes (i.e., fire, flood, other natural disaster, office burglary, major illness or death of key personnel).  If so, document the relevant facts, and document normal procedures for signing plan documents and amendments, and otherwise prepare to bear the burden of proof as to whether the document or amendment was signed.
  • For new plan documentation and amendments, establish internal procedures for handling – identify who will be the signing party or parties and outline what steps will they take to ensure they retain and store a copy of the signed and dated document.
  • Ask existing and new recordkeepers, third party administrators and other third parties who prepare plan documents these questions:
    • What is their format for storing signed documents,
    • how long they retain them, and
    • how you may access them during and after the length of your company’s relationship with them. 
  • As to the second bullet point, notwithstanding required periods for retaining tax documents, and other document retention guidelines, we recommend saving copies of signed and dated benefit plan documents and amendments indefinitely. 
  • Don’t rely on the third party to retain your documents, make sure that you safely store each document you sign and date before you send it back to the third party.  Follow up with the third party to obtain their official, final signed and dated document or amendment as stored in their records, and save that.  However keep your provisional signed and dated copy in the meantime in case the follow up process breaks down.

Take these steps not just for retirement plan documents but for health and welfare documents as well.  The tax-qualified status of your plan may hang in the balance. 

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. (c) 2020 Christine P. Roberts, all rights reserved.

Photo Credit: Top photo: Cytonn Photography; Val Lanes: MapQuest.

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Beyond the 403(b) Plan: Top 5 Things to Know About Deferred Compensation for Non-Profit Executives

Tax-exempt employers may offer deferred compensation plans to their select executives to allow for retirement savings over and above the dollar limits applicable under a Section 403(b) plan. However the rules governing these arrangements, which fall under Section 457 of the Internal Revenue Code (Code), are complex and often misunderstood.  Below are five things top things to keep in mind in this area, to get the most that the law offers without unpleasant tax surprises along the way.

1.  It’s complicated……

First, there are two types of 457 plans: 457(b) plans and 457(f) plans.  A tax-exempt employer can use both for the same executives but careful planning is advised.  The (b) plans allow set-aside (in the form of employee deferrals or employer contributions) of only $18,000 (in 2017) per year, with no age 50+ catch-up allowance.  Amounts set aside under a (b) plan are not taxed until they are distributed to the executive, an event which must be delayed until termination of employment/retirement, or on the occurrence of unforeseeable circumstances (narrowly defined).  Taxation is delayed until distribution even though the amounts are generally “vested” (no longer subject to forfeiture) when they are contributed.  By contrast there is no dollar limit on the amount that may be set aside under a 457(f) plan (subject to item no. 4, below), but the amounts are taxable upon completion of a vesting schedule (e.g., from 3 to 10 years).  Therefore distribution in full almost always happens upon completion of vesting.  Put most simply, (b) plans are a good way to double an executive’s 403(b) deferral budget, and (f) plans are a good way to help an executive catch up on retirement savings when a retirement or other departure date is within a 3 to 10 year time horizon. Further, in order for an exemption from ERISA to apply, participation in these plans must be limited to a “select group of management or highly compensated employees,” comprising no more than 5% – 10% of the total workforce, referred to as the “top-hat” group.  In a small tax-exempt employer with 10 or 20 employees this may mean only 1 or 2 executives may participate.

2.  You (usually) can’t roll to an IRA.

Generally when an executive is ready to take distribution of benefits from a 457(b) or (f) plan a taxable cash distribution is required, and rollover to an IRA is not an option. (One exception is when the executive moves to a new employer that maintains a 457(b) plan that accepts rollover contributions).  Under a (b) plan, which may allow installment distributions over a period of years, the lack of an IRA rollover option is not so severe, but in a 457(f) plan setting, which generally calls for lump-sum distributions, the tax impact can be severe and the executives should be advised to do advance tax planning with their own CPAs or other tax advisors, well ahead of their planned retirement date or other vesting trigger.  In my experience, lack of the IRA rollover option often comes as an unwelcome surprise to the covered executives.

3.  The assets belong to the organization.

Section 457 plans are non-qualified meaning in relevant part that they assets the plans hold belong to the tax-exempt organization that sponsors the plan until the date(s) they are paid out to the participants. The assets must be held in an account in the name of the organization “FBO” the 457 plan account for the name of the executive.  There is no form of creditor protection but it is possible to put in place a “rabbi trust,” so called because the trust format was first approved by the IRS on behalf of a synagogue for its spiritual leader.  The rabbi trust will not protect the 457 assets from the organization’s creditors, but it will prevent the organization from reneging on the deferred compensation promise to an executive.  This is particularly helpful for an organization that anticipates changes in its board structure after approval of a 457 arrangement.

4.  The normal “reasonable compensation” rules still apply.

Tax-exempt organizations must pay only reasonable compensation, in light of the services provided, to employees and other individuals who comprise “disqualified persons,” a category that includes executive directors and other “C-suite” members. Under the “intermediate sanction” regime the IRS imposes excise taxes on individuals who benefit under, and organization managers (e.g., board members) who approve, compensation arrangements that fail the reasonableness standard.  Deferred compensation arrangements must be reasonable in light of all other compensation and benefits provided to the executives in question and in most cases this will require a third-party compensation consultant’s evaluation and review.  This is a vitally important and often-overlooked piece of deferred compensation compliance in the tax-exempt arena.

5.  DOL notification is required.

As part of the ERISA exemption for top-hat deferred compensation plans, a tax-exempt organization must provide a “top-hat notification letter” to the Department of Labor within 120 days of implementing such a plan. Top-hat letters must be filed electronically.  Failure to timely file a top-hat letter could mean that your deferred compensation plan is liable for ERISA penalties for failure to file annual information returns (Form 5500), to hold plan assets in trust, to make certain disclosures to participants, and on a host of other compliance points.  The Department of Labor permits late filing of top-hat notification letters for payment of a modest fee.  If your organization has a deferred compensation plan in place you should have ready access to a copy of the top-hat notification letter (or confirmation of its online filing) and should consider the DOL correction program if you cannot do so.

Having practiced law in Santa Barbara, California, a haven for charitable organizations, for over 20 years I have had the privilege of working with these special deferred compensation plan rules in many different factual settings and would be happy to help your organization navigate them in order to best retain and reward your valued executives.

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Reality Check on IRA Investments in Real Estate

Multiple times each year I am asked by prospective clients whether, and how, they can invest traditional IRA assets in real estate.  In this time of distressed real estate and very low interest rates, many investors have maxed out on their after-tax investments in real estate, and their IRA account balances beckon as a new source of investment capital.  If these folks look online, they will find many sources of purported “advice” on how to get rich through IRA investments in real estate.  Unfortunately, the information available online usually obscures or overlooks altogether some significant practical and tax hurdles to making IRA investments in real estate work from both the technical/legal and “return on investment” perspectives.

Below I summarize those obstacles.  They are not barriers, per se, but prospective investors should assess them carefully, preferably in consultation with their attorneys, CPAs, or other tax advisors, before committing IRA assets to an investment in real property.    Failure to steer clear of them could result in immediate taxation of the entire IRA account – including conventional investments.

  1. Understand How the IRS Views Your IRA

A very important concept that much of the online marketing around IRAs overlooks is that, from the perspective of the IRS:

  • the IRA is solely meant to provide a source of retirement income and is not a ready source of capital for an investment opportunity; and
  • You are a fiduciary with regard to your IRA account.

The IRS applies a term – prohibited transaction or “PT” – to any use of IRA assets for personal gain other than preservation of a retirement income stream.  The prohibited transaction rules disallow a number of specific transactions, such as selling real estate to or buying it from your IRA, or personal or immediate family member use of real estate owned by an IRA, but they also generally prohibit “self-dealing” which is defined to include any act of a fiduciary (i.e., you) by which IRA income or assets are used for the fiduciary’s own interest.   Examples of self-dealing could include purchase of real estate built on speculation by a son in law, purchase of real estate adjoining your own property or that of a family member in order to control how the property is used and who lives there, or , outside the real estate context, use of IRA assets alongside personal assets in order to meet a minimum investment account threshold.

If your IRA investment in real estate constitutes a prohibited transaction of any stripe, the total account balance of the IRA will be treated as if it were distributed to you on the first of the year in which the investment is made, and thus included in your taxable income for that year.  If you are under age 59 ½, you also may have to pay an early distribution penalty equal to 10% of the prohibited investment.

Even if the purchase transaction satisfies PT rules, management of the IRA-owned real estate can also trigger violations, as is discussed in section 4, below.

  1. Analyze the Tax Consequences:  Income Tax Rates, versus Capital Gains (plus deductions)

Investing IRA assets in real estate means that gains on your investment  –  when realized through sale of the real estate and distributed from the IRA – will be taxed at regular income tax rates, rather than the lower capital gains rates that apply to after-tax real estate investments.  Also, during the time that your IRA holds the real estate, depreciation and the many deductions for property expenses claimed on Schedules C or E will not apply as they would to after-tax real property investments.

  1. Pay Cash – Avoid Unrelated Debt Financed Income

Your IRA must pay cash for the real estate, otherwise tax will be owed on “unrelated debt financed income” under Internal Revenue Code Section 514 if the leveraged property generates income (such as rents) or if it is sold for a profit while the mortgage is still outstanding (or within 12 months of paying it off).   The IRA trustee or custodian must pay the tax.

In determining how much your IRA can afford to pay for a parcel of real estate, you must arrange ahead of time, preferably with the help of a CPA or other tax advisor, to maintain liquid investments in the IRA to pay off certain recurrent costs and expenses, and for other reasons outlined in 5 – 7, below.

  1. Follow Correct Procedures (the Natalie Choate 4-Step Test)

As mentioned, the IRS views you as a fiduciary with regard to your own IRA.  Because the PT rules prohibit an IRA fiduciary from engaging in business transactions with the IRA itself, you will need to use third parties both to purchase the real estate, and to manage the real estate.  Natalie Choate, a nationally recognized authority on the estate planning aspects of IRAs and qualified retirement plans, specifically recommends the following four steps:

  • Find a specialized IRA  custodian.  Not all IRA custodians are well versed in the intricacies of the prohibited transaction rules, and how real estate investments may trigger violations.  You will want to find a bank custodian who has experience in this area.  Work through trusted contacts such as your CPA or other tax advisor until you have found the right match.
  • Custodian engages in purchase transaction, not you.  The PT rules require that the IRA custodian, not you as IRA fiduciary, uses your IRA assets to purchase the real estate.  You cannot buy the real estate and transfer it to your IRA, or sell it to your IRA.  The latter transaction would be a PT; the transfer would not work because generally only cash may be contributed to an IRA.
  • The Custodian engages a third party property manager. This step is recommended if your real estate has residential tenants or commercial tenants in anything other than a “triple net” lease requiring that they assume costs the landlord otherwise would pay.  The property manager, not you, should run the property (e.g., make repairs, collect rent, pay expenses and property taxes, etc.) and send the IRA custodian a check each month that is net of all such costs.  This arrangement makes it unlikely that you will intermingle your personal assets with the IRA assets, for instance by directly hiring a painter or gardener, or by paying a bill associated with the IRA owned property.
  •  No family use or sweat equity.  For the same reasons that a third party property manager is recommended, you must avoid any personal use of the IRA-owned real estate, or use by direct family members.  Even use by extended family members or family friends could comprise a “self-dealing” type of PT as described above.  You must also resist the urge to work on the property yourself, show apartments, or have family members fill any of these roles.  Ideally, your property manager will anticipate and take care of such needs on an arms-length basis, without involving you.
  1. Set Aside Liquid IRA Investments for Required Minimum Distributions

When you reach age 72, the IRS requires that you begin taking annual minimum required distributions from your traditional (i.e., non-Roth) IRA.  If you have multiple traditional IRAs, you can choose one from which to take distributions, but you must pool all IRA account balances together to determine the minimum required amount you must withdraw each year.  Failure to timely take out a sufficient amount could result in a 50% tax, based on what you should have withdrawn.  Needless to say, minimum required distributions are most easily made from liquid IRA investments – stock that can be sold, money market accounts, etc.  Before investing IRA assets in real estate, make sure that you preserve sufficient liquid IRA investments from which to take required minimum distributions.  You CPA or other tax advisor can help you do some advance planning in this regard, to determine the principal amount you should set aside for this purpose, and income you can expect it to generate.

Failure to preserve liquid investments for this purpose will make it very hard to take minimum required distributions.  You might have to distribute fractional interests in the IRA-owned real estate, which would be an expensive process (both in determining the value of the fractional interests, and in documenting the interest transfer).

  1. Set Aside Liquid IRA Investments for Annual Valuations of the RE Investment

Most reputable IRA custodians will require annual valuations of real estate investments or other non-traditional investments (privately held stock, etc.)  The valuation may cost several thousand dollars, possibly more.  The IRA must pay for this expense; you cannot use personal funds.  Before committing IRA assets to the real estate purchase, you need to determine how much in liquid IRA investments you need to aside in order to pay this recurrent expense from either the liquid investments themselves and/or anticipated investment income they generate.

  1. Set Aside Liquid IRA Investments for Property Taxes, Expenses, Insurance Improvements, Management Fees

As mentioned, your third party property manager will be using IRA funds to pay property taxes, maintenance and other expenses, insurance, improvements, and will also draw on the IRA to pay its own management fees.  Before committing IRA assets to the real estate purchase, you will need to determine how much in liquid IRA investments you need to set aside in order to pay these expenses from the investments themselves and/or anticipated investment income they generate.  Some amounts will be predictable and recurring; others, such as large repairs (roof replacement, etc.) are not predictable and you will have to use good judgment in estimating a set-aside.

Bottom line, IRA investments in real estate can be done, but there are many rules that must be followed to avoid disqualification of the IRA and immediate taxation of the entire IRA account. The availability of required minimum distribution amounts, the loss of capital gains treatment, and the self-dealing restrictions, generally make an IRA investment in real property unsuitable and problematical at best.  For investors who are still “game,” some advance financial and tax planning strongly is advised both before the transaction occurs, during the life of the real estate investment, and well in advance of any minimum required distribution start date.

Finally, you will note that this post does not discuss strategies using business entities within an IRA, such as IRA-owned single member limited liability companies (“LLCs”).   Often marketed as “checkbook control” IRAs, these arrangements raise a host of compliance issues over and above the ones discussed below.  The Groom Law Group has an excellent article debunking this and a number of other questionable IRA strategies that you can read here.

Photo by Rowan Heuvel on Unsplash