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2011 Employee Benefits & Payroll Subgroup

A. Employer and Insurer Reporting Under the Patient Protection and Affordable Care Act For Years Commencing on or after 2013

Recommendations

With respect to the Patient Protection and Affordable Care Act, Public Law 111-148, (the Act) and the reporting requirements for employers and insurers that relate to employee benefit information and employee tax information, the IRPAC has the following recommendations regarding these requirements:

1. The IRPAC recommends that given the potential increase in the data required to be provided to an employee, the IRS should consider the implementation of a separate form other than the Form W-2, Wage and Tax Statement, to report any additional information that may be required to be reported in the future.

2. The IRS should consider developing a separate electronic reporting mechanism for reporting rather than trying to modify the Form W-2 formats, given the complexity of the data.

3. The IRPAC requests that the IRS clarify the process for reporting this information to employees electronically. The information may be accessed by employees in much the same manner as Forms W-2 are currently accessed either through employer portals or other electronic means. This would also include the reporting requirement that becomes effective March 2013 regarding information employers must provide to new employees and current employees.

4. The IRC § 6055 and § 6056 contain several duplicative requirements regarding the reporting of employee and employer information. The committee recommends that the IRS study the potential for providing an optional alternative and streamlining these reporting requirements, while permitting the maximum flexibility with respect to data reporting and reporting methods.

5. The IRS should permit employers to provide for an automated voice response phone system (VRU) as an additional option to the information contact phone number currently prescribed.

6. The IRS should clarify that employers are not required to report health coverage details on any Form W-2 that is issued prior to the January 31 annual due date.

7. The reporting requirements related to this reporting should be defined by early 2012 and no later than June 30, 2013, to permit sufficient lead time for employers and insurers to comply.

8. With regard to the Medicare tax increase for high earners, we recommend that the IRS report this tax information on Form W-2 in box 9 and on a separate line on the Forms 94x series.

9. The IRS should provide the required information and mechanism for reporting the Shared Responsibility Assessment (SRA) that employers will be required to report after 2013.

10. The IRS should consider allowing employers and providers the option of using the special accounting rule, similar to the reporting of certain fringe benefits, for reporting W-2 health care valuation amounts.

Discussion

1. Given the fact that the Form W-2 already includes as much data as can be reflected on a single page, the inclusion of additional data would undoubtedly cause the form to become a multiple page form. Mid-year plan changes and changes in coverage status, marital status, or dependents may require many data records per employee. The annual processing in this instance, given the fact that the form can be six pages, would make the preparation of the form increasingly difficult and costly. A separate form; e.g. “1099 HC” which would reflect any additional data that may be required in the future would be more efficient. Likewise it would cause less confusion to the employee.

2. Due to the complexity of the information that would be required to be reported, the development of a separate electronic reporting mechanism would be more beneficial than the modification of existing W-2 reporting.

3. Employers will need the ability to report to the employees this information electronically rather than provide the information by paper form. Employers will need the ability to use their existing internal employee benefit electronic portals to disseminate the information. The electronic communication of such statements is a benefit to the employee and also a cost benefit to employers.

4. There exists much duplication of employee data elements to be reported in the applicable sections of the Act. It would be very beneficial for the IRS, insurers, and employers if this information could be optionally consolidated and streamlined so that it is transmitted once using the most efficient method available to the insurer or employer. This would effectively reduce administrative burden and cost for all parties. However, because information is generally stored in separate systems, if not different organizations, the IRS should also permit separate reporting of IRC § 6055 and § 6056 data.

5. In both sections of the Act, the regulations require a phone number for information contact be provided by the employer. IRPAC has in the past made several recommendations on this issue. It is very difficult, particularly for large multinational employers, to provide an appropriate phone contact for all employees. Current practice by many corporations of all sizes is to provide VRU. This practice serves the intent of the regulations.

6. It would be extremely difficult for employers to gather the IRC § 6055 health coverage detail information and timely submit the information for those terminated employees who request their Forms W-2 before the January 31 annual due date. In many instances this information must be gathered from third party sources such as insurance carriers. We believe that this information should be reported only on the Form W-2 which is due on January 31 or other form e.g. Form “1099 HC”.

7. Reporting of the employee information may be required as soon as February 2014. It is imperative that insurers and employers have ample time to make the necessary system modifications. Much of the data required to be reported is not housed within payroll systems or controlled by the same group that manages the payroll data for Form W-2 reporting. Thus it may be necessary to develop new mechanisms to securely communicate this data between employers, insurance carriers, and affected parties.

8. Based upon discussions that have taken place concerning the reporting of this tax, it seems that the recommendation that was made would create the least amount of administrative and programming burden to employers both from a payroll processing and annual Form W-2 filing perspective.

9. IRS should develop a separate quarterly excise tax return to permit employers to self-assess and report the SRA. Deposit requirements should be established to benefit from a “pay-as-you-go” system, avoiding very large unanticipated annual assessments. There should also be an annual reconciliation of the quarterly SRA filings and the annual reporting of health coverage and full-time employee status under IRC § 6056.

10. Due to the use of third party insurance providers and multiple plans used by employers, it may be difficult to consolidate the various valuations for each plan and incorporate the total on the Form W-2 by the annual filing date. However, if the employer were allowed to use the rule similar to the special accounting rule then the calculation could be made timely and incorporated in the annual form.

B. Health Care Valuation on Form W-2

Recommendation

IRS should exempt sick pay providers from this reporting requirement and otherwise more fully explain who is responsible for the Code DD, Cost of Employer-Sponsored Health Coverage, reporting as W-2 reporting is often performed by both employers and third parties.

Discussion

In response to the issuance of interim guidance on informational reporting to employees of the cost of group health insurance coverage (IRS Notice 2011-28), IRPAC submitted a comment letter (see Appendix B) on June 28, 2011, that included numerous recommendations.

IRPAC once again would like to highlight the need for relief in the area of sick pay reporting. Many employers use third party sick pay providers to handle W-2s for short-term and/or long-term disability payments. These providers operate on separate systems from employers and in most cases do not have access to health coverage data on individual employees. This reporting obligation places an undue burden on these providers and employers/plans that would be required to pass along this information from the various health care plan administrators.

C. Premium Assistance Tax Credits

Recommendations

IRPAC makes the following recommendations:

1. The Fact Sheet released along with the proposed rule on August 12, 2011, should clearly explain when the tax credits are available and when they are not available. More examples should be added.

2. IRS should look to reporting requirements already imposed on plans and employers to determine how these may be used to assist tax credit applicants.

Discussion

The Act creates premium assistance tax credits for eligible individuals who purchase health insurance coverage through exchanges, beginning in 2014 (IRC § 36B(b)(1)). The premium assistance tax credits generally are available to individuals with household incomes up to 400 percent of the federal poverty level.  The credits are available on a sliding scale. The amount of the credit will be based on the percentage of income that the cost of the insurance premium represents. Premium assistant applicants will be required to report their income to the exchange and this information will be provided to IRS to assist in determining eligibility.

Guidance released in August 2011 as proposed regulations (REG-131491-10) addressed a pressing issue for employers and plan sponsors that needed to be resolved immediately to allow employers to begin future health benefit planning. Specifically, the issue was whether family members would be eligible for the tax credits when the employee had access to affordable coverage through the employer-sponsored plan, but the family coverage was unaffordable. We commend IRS for answering this question and seeking public comment.

In addition to the notice of proposed rulemaking released in August 2011, the Treasury Department released a Fact Sheet. While the Fact Sheet is a good start, it does not clearly explain the important issue of when the tax credits are available and when they are not available. The Fact Sheet provides three examples that calculate the value of the tax credit for a family of four. These examples fail to explain that they are based on the assumption that either there is no qualifying coverage or the self-only premium for employer-sponsored coverage is unaffordable. We recommend that this clarification be added to these examples. Other examples are needed illustrating the position taken in the proposed regulations that family members are not eligible for the tax credits when affordable self-only coverage is provided through an employer-sponsored plan, but family coverage is not affordable. These additions will serve to inform the public and permit an open discussion of this issue.

We have many questions and concerns about how IRS will arrive at the eligibility determination for the premium assistance credits given that IRS must have certain information about the individual’s employer-sponsored plan. One of the conditions to receive a tax credit is ineligibility for affordable employer-sponsored coverage. We recognize that one piece of the new reporting requires employers and insurers to furnish IRS with plan information by January 31, based on the prior calendar year. Employer-sponsored plans often change from year to year, as premiums, benefits, and cost-sharing are adjusted for medical inflation. The information furnished to the IRS from the employer/insurer reporting return may be irrelevant by the time the IRS receives an application for a premium assistance tax credit.

We understand that as part of the application for the premium assistance credit an individual will provide information on the plan available through their employer. Will the IRS rely on the applicant’s representation of the employer-sponsored plan if it differs from the employer/insurer report filed with the IRS no later than January 31? If not, how will the IRS verify the accuracy of the plan information provided by the applicant? The plan information is critical as it is one of the factors determining eligibility for the premium assistance credits.

To address these concerns, the IRS and Department of Health & Human Services should review the new disclosure rules for group health plans (Summary of Benefit and Coverage, RIN 1545-BJ94, Federal Register, August 22, 2011) to determine how these newly required documents could be used to assist employees in answering plan-related questions on the exchange tax credit application. 

D. Shared Responsibility

Recommendations

IRPAC encourages IRS to address the following questions:

1. Will a penalty under IRC § 4980H(a) apply when the employer offers employee-only coverage, but does not offer a family coverage option?

2. Will a penalty under IRC § 4980H(b) apply based on the affordability of self-only coverage and not on the affordability of employee plus one dependent, or employee plus family?

3. Will the employer be required to self-assess the penalty, or will the IRS calculate the penalty and send a penalty assessment to the employer?

IRPAC recommends that employers be permitted to self-assess the SRA at least quarterly, to pay estimated amounts due on a specified schedule, and to reconcile annually against the annual Health Coverage Report under IRC § 6056.

Discussion

The  Act imposes different penalties on employers depending on whether they drop coverage or offer unaffordable coverage. We have questions concerning how these penalties will be calculated.

The Act imposes penalties on certain employers that fail to offer their full-time employees the opportunity to enroll in minimum essential coverage under an employer-sponsored plan and have at least one full-time employee who enrolls in an exchange-based plan and receives a premium assistance credit.

The Act imposes a different penalty on certain employers that offer full-time employees the opportunity to enroll in an employer-sponsored plan and have one or more full-time employees enroll in an exchange-based plan and receive a premium assistance credit.

We have raised only a few of the many issues and questions surrounding the premium assistance credits and penalties. IRPAC looks forward to assisting the IRS in exploring these and other issues further.

E. Form 5500-EZ Registration

Recommendation

IRPAC recommends that IRS develop a voluntary process whereby a sponsor of a plan that is currently exempt may file a registration statement in order to receive any informational filings the IRS may have that relates to their responsibility to file Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan, or other plan requirements.

Discussion

IRPAC recognizes that many small employers file Form 5500-EZ late because they do not require filing unless certain events occur such as total plan assets exceed $250,000. A plan sponsor can go many years without the requirement to file Form 5500-EZ. A plan may never need to file Form 5500-EZ until it is terminated or the plan assets exceed $250,000. Because the plan sponsor has never filed Form 5500-EZ, the requirement to file upon plan termination may not be known.

In lieu of filing a Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan which is a filing under the Department of Labor (DOL) computerized ERISA Filing Acceptance System (EFAST2), IRPAC suggests the IRS develop an annual registration process that is voluntary by the sponsor of the one-participant plan. Because many of these small plans do not retain ongoing service provider support, IRPAC believes this will encourage filing and will promote education within the small plan community alleviating future Form 5500EZ delinquent filings.

F. Form 5500-EZ Delinquent Filer Program

Recommendation

IRPAC recommends:

1. That a program be created to allow delinquent Form 5500-EZ filers to voluntarily disclose the failure to file the information return in a timely manner.

2. That the program be permanent.

3. That any such program should encourage compliance with a penalty structure that supports disclosure of multiple years and/or multiple plan filing failures with a reduced penalty burden.

Discussion

IRPAC believes that there are many delinquent Form 5500-EZ filers that would use a voluntary program to correct filing failures should the IRS create a permanent program for this form. Because one-participant plans may have unintentionally established multiple plans with multiple filing requirements, such a program should be sensitive to reducing the burden on these small businesses. Thus, IRPAC recommends a multiple year and multiple plan penalty structure that is sensitive to the nature of the small business entities that sponsor these plans. The ideal program would encourage small businesses to file delinquent returns with a flat penalty regardless of the number of years or number of plans to be filed.
Currently, the DOL administers a Delinquent Filer Voluntary Compliance Program (DFVCP) for Form 5500, Annual Return/Report of Employee Benefit Plan, filers other than the Form 5500-EZ. The IRS should establish a permanent program for the Form 5500-EZ filers. There is a distinct burden on small plans that often find themselves with multiple years to file or multiple plans they never realized they had because of the methods used by the financial institutions to establish a one-person plan.

It has been common to find that a plan sponsor has inadvertently adopted multiple retirement plans. As a trustee of the plan would move investments to diversify its portfolio, the financial institution would establish a plan with a different plan number instead of one contiguous plan number. This increases the delinquent filers because each plan would have its own filing requirement. Because the plan sponsor did not intend to sponsor more than one plan, it is a burden on these small businesses to pay a fee for each year and each plan that is delinquent.

Filers of Form 5500-EZ are often delinquent because the requirement for filing may change as the value of the plan assets change or as a new employee becomes an eligible participant. This is unique to the Form 5500-EZ filers.  IRPAC requests consideration of this issue in the penalty structure for Form 5500-EZ delinquent filers.

G. Employer Identification Numbers for Retirement Plans

Recommendations

IRPAC makes the following recommendations to the process for employer retirement plans to obtain a trust Employer Identification Number (EIN):

1. Based on the lack of clear guidance on the need and the proper procedure for obtaining EINs for qualified plans’ trusts, IRPAC strongly recommended in our 2010 report changes to Forms 5500 and SS-4, Application for Employer Identification Number (and related instructions), to clarify these rules and encourage plan sponsors to obtain a trust EIN for qualified plans/trusts.

2. More specifically, IRPAC suggested clarifying the outdated and confusing instructions for obtaining an EIN for qualified plans/trusts.

3. IRPAC recommended that specific instructions and guidance on the Employee Plan (EP) website be developed regarding the need for and process to obtain a plan’s trust EIN, and recommend that the plan’s trust EIN be added as an optional box on Form 5500.

4. Although IRS was helpful in promptly adding language to the EIN landing page since the issuance of the 2010 Report, and understanding that it takes time to incorporate changes into the instructions and forms, we recommend that the modifications to the instructions and forms to be issued in the next reiteration of these publications include modifications specified in the 2010 report.

5. IRPAC recommends that its suggestions to the forms, instructions, and publications are cross-referenced from the EP website to the various related forms, instructions, and publications that would be helpful in this area.

Please note that this discussion does not alter the approach taken by third party service providers and asset custodians that report using the provider's/custodian's EIN for Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., and Form 945, Annual Return of Withheld Federal Income Tax, reporting, which IRPAC recommends also be reflected on the Form 5500, along with increased IRS clarification on this reporting option.

Discussion

Following IRPAC’s 2010 Public Report, the Form SS-4 website landing page for the EIN process was updated with brief language about the nature of the EIN process for employee benefit plans. IRPAC commends the IRS for looking to a prompt method to help clarify the confusion with the retirement plan application process. However, the SS-4 Instructions and Publication 1635, Understanding Your EIN, still need to be updated accordingly with the IRPAC recommendations.

Many small plan employers do not realize that the EIN they use to report earnings for their retirement plan should not be the same as the plan sponsor number. They also do not realize that the process for withholding of pension plan account income tax should not be co-mingled with the payroll of the plan sponsor. IRPAC believes the best way to communicate this is specific information and articles on the EP website.

IRPAC’s concern with the communication to sponsors of retirement plans under IRC § 401(a) regarding the need and application process for an EIN for the plan’s trust relates to the education process inasmuch as the potential penalties for failing to remit pension withholding in an appropriate manner. Many plan administrators use the EIN given to the plan sponsor for its business, making the tracking of withholding and payments on behalf of plan participants co-mingled with the regular payroll of the employer and thus not separate.

In working with IRPAC the past year, IRS has been helpful in changing the information that is communicated on the landing page for the EIN requirements on the IRS website. We commend the effort to complete the web-based information in a prompt manner.

However, IRPAC also recommends that the instructions for the EIN application process be clear about the need, use, and application process for a separate retirement plan EIN. In order to encourage plan administrators and plan sponsors to obtain an EIN for the plan’s trust, it is ideal to have guidance contained in the form instructions. Moreover, the instructions should contain examples of the proper use for the EIN, including how to deal with plan and employer mergers and acquisitions.

H. Automatic Extension of Filing Deadlines for TE/GE Issues

Recommendation

IRPAC recommends that IRS establish a system and maintain a policy that allows for an automatic extension to the original filing date for any form published in final format within four months of its due date for any TE/GE related matter. For IRPAC's more global recommendation for changes, see the IRS Guidance Plan comment letter dated June 29, 2011 (see Appendix A).

IRPAC recommends removal of the signature requirement on Form 5558, Application for Extension of Time To File Certain Employee Plan Returns,  because it increases the burden of filing the return timely and accurately. It is inconsistent with historic treatment of data on the Form 5500.

Moreover, IRPAC recommends that the IRS work with the retirement community in implementing new forms and changes to existing forms, and making filing information readily available (e.g., EP website). For example, periodic calls, similar to the payroll community calls, can be established for the retirement community in order to address reporting issues, along with Frequently Asked Questions on the EP website. This approach can be used for Forms 8955-SSA, Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits, and 5558, which still have open issues (see below).

Discussion

IRPAC is concerned with the issuance of forms within four months of their original due date. With the added complexity of additional data needed for forms that are issued near an original due date, plan sponsors are not able to turn around the data and have the burden of working with their service providers to collect that data in a timely manner. Should a form be published in its final form within four months of its original due date, the IRS should be able to internally provide for an automatic extension to the form.

In an ideal environment, the IRS would issue forms that do not have material changes prior to this four month benchmark. If this is not possible, the IRS should consider the impact to software vendors and plan sponsors when there is a new form or if substantive changes are made to a form. An automatic extension to the form’s original due date anytime a form is published within four months of its due date would provide stability to plan sponsors as well as the service provider and software industry.

Critical to the use of electronic medium used in today’s submission of many information returns, it is very important to understand that software vendors need sufficient time to create the form in proper electronic format, the payer community requires sufficient processing time once forms and instructions are issued in final form by the IRS in order to successfully implement changes to information returns, and employers require lead time to gather and transmit to their service providers the information requested on the information return. Employers are not able to use many forms the day they are finalized and the vendors do not deliver them to employers until they have finalized their software implementation. Internal processing procedures need to be changed by service providers who complete many of these forms on behalf of employers.

Although appropriate and sufficient lead times may vary depending on the extent of the changes to a form and the type of payment, at a minimum the IRS should grant an automatic four month extension of any filing deadline if the IRS issues the final form and instructions within four months of the filing deadline. We believe that this should be a standard of internal IRS practice and not dependent upon practitioner individual and specific requests with each delayed issuance of any information return.

Moreover, once the forms are finalized, the IRS should focus on communicating the changes to the retirement community, and making filing information readily available to facilitate proper tax administration. For example, there are still a number of open issues regarding Form 8955-SSA and Form 5558, and additional guidance would be welcome.  Specifically:

Form 8955-SSA:

1. Confirm that no action is needed to take advantage of the January 17, 2012, deadline for 2009 and 2010 plan years.

2. Clarify whether the January 17, 2012, deadline applies to 2011 short plan years, and explain what action should be taken to report while waiting for the 2011 form.

3. Clarify whether a wet ink signature must be kept on file, and if the sponsor signature information in the Filing Information Returns Electronically (FIRE)  file (typed name and signed date) are required fields.

4. Clarify what is necessary to meet the participant notice requirement in light of the expansive benefit statements and the lack of clear guidance in this area.

Form 5558:

1. Clarify who is authorized to sign for a Form 8955-SSA extension, and whether that would include the FIRE filer who is the third party service provider.

2. Clarify what action will be necessary to remove the signature requirement for a Form 8955-SSA extension, as it is extremely burdensome for record keepers and was never previously required for this information.

I. Clarification Needed on Form 1099-R Instructions

Recommendation

In reviewing the Form 1099-R and related instructions, we recommend that the following issues be clarified: (1) death benefits paid from the employer are not reported on Form 1099-R, (2) reporting of IRA distributions in box 2a, (3) reporting for nonresident aliens and Puerto Rico citizens, and (4) reporting of qualified charitable distributions (QCDs) under IRC § 408(d)(8), qualified health saving account (HSA) funding distributions described in IRC § 408(d)(9), and payment of qualified health and long-term care insurance premiums for retired public safety officers described in IRC § 402(l).

Discussion

1. Death benefits from the employer that are not part of the qualified plan are not subject to 1099-R reporting, and the 2011 Instructions for Form 1099-R should be revised accordingly. Specifically, page 1, "Specific Instructions for Form 1099-R" should be revised to delete the second paragraph and page 8 Box 1 "Gross distribution" should be revised to delete the second to last paragraph.

2. There is confusion regarding the 2011 Form 1099-R Instructions on page 8 and page 10, regarding the reporting of IRA distributions in box 2a. The general box 2a instruction says to leave box 2a blank if unable to ascertain the taxable amount, but the specific IRA instructions state that box 2a should be the same as box 1. Therefore, to clarify that IRA distributions should not result in a blank line 2a, IRPAC recommends that the following sentence be inserted on page 8 (following the reference to the blank line): "(For IRA distributions, the preceding sentence does not apply; see Instructions on page 10 "Traditional, SEP or SIMPLE IRA").

3. Reporting of retirement payments to nonresident aliens and Puerto Rico residents should be more fully described in the Form 1099-R and 1042-S, Foreign Persons U.S. Source Income Subject to Withholding Instructions. We understand that international benefit issues are being considered by the IRS, and prior to audit activity in this area, IRPAC strongly recommends that additional education and instructions be provided to plan sponsors as to the proper reporting for all types of participants covered by U.S. tax qualified plans/IRAs.

4. Please confirm that no special rule apply to QCDs under IRC § 408(d)(8), HSA funding distributions described in IRC § 408(d)(9), and payment of qualified health and long-term care insurance premiums for retired public safety officers described in IRC § 402(l). Page 1 of the 2011 Form 1099-R Instructions indicate that no special reporting applies, which we assume means that these payments are reported as otherwise taxable distributions under the applicable provisions, and that January QCDs are not separated from other QCDs.  We note that some may take the position that there is no 1099-R reporting on IRC § 408(d)(9) transfers because it is a trustee-to-trustee transfer that is not reportable. Additional clarification is needed.

J. Form 1099-R Reporting and Withholding Guidance for Certain Installment Payments

Recommendation

IRPAC recommends that the IRS issue reporting and withholding guidance on two types of payment streams from qualified plans, commercial annuities, and IRAs covered by IRC § 3405,collectively, the "accounts", and that this guidance be prospective in nature, as IRPAC anticipates that based on the lack of clear guidance in this area, varying methods have been adopted.

The first payment stream from an account is installment payments that are a fixed dollar amount paid at least annually and are scheduled to be paid out until the account is exhausted, i.e., if no subsequent participant action is taken, the payments will be paid over at least 10 years, but that the participant can stop these payments at any time, and these payments may include a one-time upfront election by the participant to include a fixed annual increase for inflation.

The second payment stream is a lifetime income guaranteed payments from an account paid for the life of the participant, which generally can also be modified or stopped at any time by the participant, at least until the account balance is zero.

Discussion

IRC § 3405 provides for mandatory 20 percent withholding on eligible rollover distributions, and voluntary wage withholding for periodic payments that are not eligible for rollover treatment. An eligible rollover distribution excludes any distribution that is one of a series of "substantially equal periodic payments" made (not less frequently than annually) over any one of the following periods:  (1) life of the employee/beneficiary, (2) life expectancy of the employee/beneficiary, or (3) a specified period of ten years or more. For this purpose, in the case of payments from a defined contribution plan to be distributed in annual installments of a specified amount until the account balance is exhausted, the period of years is determined using reasonable actuarial assumptions.  Treas. Reg. § 1.402(c)-2, Q&A-5(d).

Regarding the cost of living adjustment, several private letter rulings support a one-time upfront election of three percent without a loss of "substantially equal" status, e.g., Private Letter Rulings (PLR) 9747045, 9536031. Moreover, the legislative history to IRC § 72(t) states that a series of payments will not fail to be substantially equal solely because the payments vary on account of "certain cost-of-living adjustments" and that "the Secretary may prescribe regulations setting forth other factors (consistent with the factors that preceded under IRC § 401(a)(9)) that will not cause payments to fail to be considered substantially equal."  1986 Act Blue Book, at 717. The IRC § 401(a)(9) regulations for annuity payments from a qualified trust under a defined benefit plan expressly permit an increase by a constant percentage, at a rate that is less than five percent per year.  Treas. Reg. § 1.401(a)(9)-6, Q&A-14.

In contrast, however, PLR201120011 provides that, for purposes of § 72(q), a constant one to four percent adjustment, as elected by the participant, results in loss of "substantially equal" status. Its analysis is focused on the belief that (1) the adjustments fall outside of IRC § 401(a)(9) account balance rules described in Revenue Ruling 2002-62, which was intended as relief following Notice 89-25, which Notice has historically been viewed as only a safe harbor method to meeting these requirements, and (2) a participant's election of between one and four percent annual increase was not a cost of living adjustment.  Notably, these payments and the qualified plan payments are reported on Form 1099-R.

Although this 2011 ruling addresses only IRC § 72(q), there is a concern that as the same "substantially equal" requirement applies for IRC § 72(q), 72(t), 402(c), and 3405, this ruling signals a potential IRS change in the proper reporting and rollover approach (to mandatory 20 percent withholding and eligible rollover treatment) for installment payments from qualified plans. However, prior to undertaking extensive re-programming and distribution changes and trying to explain potentially a different rollover and withholding treatment depending on whether the annual three percent adjustment is elected, the reporting community needs to understand from the IRS the full impact of this ruling to all accounts.

Moreover, there is no guidance on the proper treatment of guaranteed lifetime payments for purposes of IRC § 72(t), 402(c), and 3405.  It is important to understand the proper reporting as the payer may be liable if insufficient withholding is taken, along with potential reporting penalties under IRC § 6721 and § 6722, and the participant may face an annual six percent excise tax if the amounts are improperly treated as eligible for rollover and rolled to an IRA.

K. Erroneous Claims for Itemized Deductions for Business Expenses

Recommendation and Discussion

IRS officials have indicated that there has been a problem with individual taxpayers claiming itemized deductions for unreimbursed business expenses when filing Forms 1040, U. S. Individual Income Tax Return. IRPAC has explored this problem and offers the following recommendations to enable IRS to be better positioned to identify these types of situations where an individual who is reimbursed for a business expense also claims an itemized deduction for the very same item:

1. IRS should obtain data on the scope/risk of erroneous claims for business expenses. IRS should perform a study to determine the current level of non-compliance in this area to ascertain if the cost of changes to improve compliance would be outweighed by any additional benefit. IRS should consider costs to employers, service providers, and software developers, as well as costs to IRS. All of the above mentioned stakeholders would incur additional programming, processing, and procedure costs as a result of a change to improve compliance.

2. IRS should review the use of current Code L, Substantiated Employee Business Expense Reimbursements, in box 12 on Form W-2 and consider modifying the requirement for Code L such that employers would indicate whether or not the employer has an accountable plan in place for reimbursement of qualified business expenses. For example, a ‘Y” could indicate that such a plan was offered during the tax year; and an “N” could indicate that such a plan was not offered. The indicator could be at the EIN/employer level, or at the individual employee-level, or at some other level, e.g., employee pay grade, division, group, etc., that is feasible for the employer to provide. Alternatively, the employer could indicate Y if an accountable plan was offered, and otherwise, the box L indicator would be blank. This latter suggestion, i.e., Code L Y; or leave blank, would likely be less burdensome to employers, especially small business since small businesses would be less likely than large business to have an accountable plan. However, this approach would need to be in conjunction with recommendations number six and seven below. IRPAC prefers use of box 12 to a new box as a change to box 12 would likely require less implementation cost and effort by stakeholders involved in Form W-2 processes.

3. IRS should not require that the employer post any new dollar amounts for payments made under an accountable plan on Form W-2 than are now required.  The payroll system or payroll service provider does not typically have information or data on these types of payments. Reimbursements made under an accountable plan are typically made through an accounts payable system, a travel reimbursement system, or a third party. These do not typically interface with the payroll system or provider issuing Form W-2. Requiring the posting of these types of payments onto a Form W-2 would require expansion of payroll systems to house the amounts, extensive programming, as well as costs for testing, implementation, and process and procedure changes.

4. IRS should review the current use of Code L in box 12 on Form W-2 with respect to per diems and mileage allowances, and IRS should continue such reporting only if IRS deems that this information is useful to IRS in its compliance efforts. If so, the accountable plan indicator, Y or N in the section above; or Y and blank, could be incorporated into box 12 of Form W-2 in some other fashion.

5. IRS should then consider tailoring its identification of situations where an individual claiming an itemized deduction for unreimbursed business expenses was in error to those in which Code L indicated a Y. Here, the company offered an accountable plan, and it may be the case that the amount claimed by the individual as an itemized deduction had also been reimbursed by the employer. Note however, that even if an employer offers an accountable plan, the individual may not have, in fact, been reimbursed and the claim for an itemized deduction may have been appropriate. In any event, this change may make it easier for IRS to identify potential problem situations.

6. IRS should stress in its audit guide procedures that the individual, not the employer, is responsible for providing proof of the appropriateness of any claim for an itemized deduction on the individual’s income tax return. The employer should not be burdened with responding to IRS or employee inquiries regarding positions taken by the employee on his/her individual income tax return. The employee is required to substantiate the appropriateness of the deduction that he/she took on his/her return and should not otherwise contact the employer.

7. IRS should state in the IRS audit guide that if the employer has an N under Code L or the indicator was blank, the revenue agent should not need to ask the employee to obtain from the employer a letter of certification that the employee was not reimbursed for expenses.

8.  IRS would also need to consider the need to modify language with respect to accountable plans, per diems, employer reimbursements, etc. in a variety of documents, such as Publication 535, Business Expenses, Instructions to Schedule A, Itemized Deductions, to Form 1040, IRS Publication 15,Circular E, Employer’s Tax Guide, IRS Publication 463,Travel, Entertainment, Gift, and Car Expenses, as well as language in Instructions to Form W-2.

9. Prior to making any such change, IRS should team with various stakeholder groups, including employers, payroll service providers, software developers, and IRPAC, to ensure that requirements are workable and, if so, would the changes improve the IRS’ ability to reduce the occurrence of erroneous claims for itemized deductions for reimbursed business expenses.

IRPAC welcomes the opportunity to work with IRS on this issue.

L. Business Expenses Reporting: Fringe Benefit Information Contained in IRS Publications

Recommendation

IRS officials from the Large Business & International operating division (LB&I) requested IRPAC’s suggestions on information reporting related to a variety of noncompliance items in the area of business expenses and fringe benefit reporting.  Based upon discussions with LB&I representatives and the IRPAC, the following are recommendations regarding each issue discussed:

1. IRPAC reviewed the IRS publications noted in the discussion below and provided recommendations regarding language enhancements.

2. For non-compliance in reporting stock option compensation, IRPAC recommends that a dedicated section of an IRS publication be used to explain both the employer and employee reporting obligations.

3. IRPAC recommends that no additional form be considered at this time due to the fact that it would increase burden and costs to the IRS and the reporting community. IRPAC welcomes the opportunity to provide additional suggestions to IRS on these topics.

Discussion

IRPAC review of IRS Publications

IRS officials from the LB&I requested IRPAC’s suggestions on information reporting related to a variety of noncompliance items in the area of business expenses and fringe benefit reporting that have been identified during recent audits. IRPAC reviewed a number of IRS publications that contain information on the reporting requirements for these issues.  Generally, IRPAC found that, in each of these publications, there was a varying degree of explanation of business expenses, how they are to be reported by the employer, what amounts are reportable as wages versus non-wages paid to the employee, and how to report on the employee’s Form W-2.  IRPAC suggested a number of clarifications and recommended that IRS review and edit these publications with the aim at enhancing the use of standard language terms and the use of examples/charts to reflect that reporting.

Below are some comments on the IRS publications reviewed:

IRS Publication 15 (Circular E), Employer’s Tax Guide:

1. Section 5 of Publication 15  on page 12 uses the term “specified amounts” (for example, nontaxable portion) in box 12 of Form W-2 using Code L. IRPAC suggests that it would be more beneficial to use the term “substantiated amounts” which is used in other publications.

2. Instructions for Forms W-2 and W-3: inconsistencies in wording:

a. Page 5 states that where the employer uses a per diem or allowance and the amount paid for “substantiated miles or days of traveled exceeds the amount as substantiated under the IRS rules, you must report as wages on Form W-2 the amount in excess of the amount treated as substantiated. Report the amount treated as substantiated in box 12 using Code L”.

b. Page 11 provides that Code L should be used only if the employer reimbursed its employee for employee business expenses using a per diem or mileage allowance method and the amounts that the employer reimbursed exceeds the amount treated as substantiated under IRS rules.  See section above page 5. Also, on page 11 in the first part of the sentence, suggestion is to state that the employer use the Code L only for substantiated amounts if the employer reimbursed its employee for employee business expenses. It would be better to use the same term (i.e., substantiated amounts) here as was used on page 5 and last part of the sentence on page 11.

IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses:

IRS Publication 463, addresses items impacting Form 1040 filing and Form 2106,Employee Business Expenses. It includes a chart on page 30 on how expenses are reported on Form W-2 and Form 2106. The chart should be modified to address the reporting when the employer offers an accountable plan and reimburses employees for actual expenses.

IRS Publication 525, Taxable and Nontaxable Income:

The suggestion is to include on page 3 of IRS Publication 525 references to the Instructions to Form W-2, Code L, along with the references to Publication 463.

IRS Publication 535, Business Expenses:

IRS Publication 535 addresses items also discussed in Publication 463. IRPAC suggests that both publications (1) include information on the reporting treatment when actual business expenses are reimbursed through an accountable plan, (2) include language addressing the fact that there is no required reporting on Form W-2 if the excess reimbursements, beyond actual business expenses are returned to the employer, and (3) incorporate the same terminology for the same item, e.g., substantiated amounts and excess amounts. In addition, the chart in IRS Publication 535 on Form W-2 reporting would be clearer if it separated the Form W-2 treatment of wages reported in box 1 and the amount reported in box 12 under Code L.

Non-compliance stock option compensation reporting in Forms W-2 or Forms 1099:

This guidance should include reporting for former employees on Form W-2 and for non-employees, such as directors, on Form 1099-MISC, Miscellaneous Income. This section should also describe the impact of the new cost basis reporting rules, and the employee's basis in the stock, and cover the variety of available forms of equity based compensation. See IRPAC's comment letter dated February 26, 2010 for a summary of the various equity based compensation arrangements, applicable rules, and available IRS guidance.

Payments made to lobbying firms:

With respect to the difficulty that IRS is experiencing when attempting to identify payments made to lobbying firms as these payments are nondeductible by the payer, IRPAC considered if it would be beneficial to require a special Form 1099 for these payments to lobbying firms, e.g., Form 1099-LOBBY. IRS should conduct a study to assess the level of noncompliance in this area before review of a new special Form 1099.

M. Fraudulent Forms W-2 Result in IRS Issuing Erroneous Tax Refunds

Recommendation

IRS officials have indicated that there has been an increasing incident of erroneous tax refunds being issued based on individuals’ submission of fraudulent Forms W-2 and/or fraudulent Forms 1099. The problem is exacerbated by the timing of when the refunds are issued and when IRS receives the actual employer Forms W-2 and payer Forms 1099. Due to the statutory filing dates, individuals file returns and receive refunds, in many cases, in advance of the IRS’ receipt of payer data. IRS has taken some steps to confirm or validate individual filings that appear fraudulent. For example, IRS contacts the employer/payer individually by phone or fax to request a manual verification of a suspicious Form W-2 or Form 1099. Verification is not all inclusive and is very time and labor consuming for both the IRS and the employer/payer. Some employers have responded by providing IRS with a duplicate of the W-2 file submitted to the SSA. The steps can be burdensome to employers and payers issuing Forms W-2 and Forms 1099, and, IRPAC understands these steps have not been especially effective at addressing the problem.

IRPAC has explored the issue and makes the following recommendations:

1. IRS should study the occurrence and scope of fraudulent Forms W-2 or Forms 1099 that have resulted in erroneous tax refunds. This data will be important to ensure that the cost and burden of any additional controls are outweighed by the benefit to IRS.

2. IRS should team with various stakeholder groups, including SSA and IRPAC, prior to implementing changes that will impact individual filers, payers, service bureaus, software vendors, and others affected by any proposed change to the timing, frequency, and/or nature of information reporting.

3. IRS should not implement any change that would increase the frequency of information reporting related to Forms W-2 or Forms 1099. Specifically, IRS should not implement quarterly wage and tax reporting as payer and payroll systems are configured to create and issue Forms W-2 annually, at the conclusion of the calendar year. Any requirement for more frequent reporting, e.g., quarterly reporting, would be a very significant change and unlikely to be implementable given that payers must gather a wide variety of data from other sources and vendors in order to comply to complex Form W-2 reporting requirements, e.g., fringe benefit, retirement plan, and health care information must typically be collected from non-payroll sources for Form W-2 reporting purposes.

4. If more restrictive filing deadlines are considered, IRS should work with stakeholder groups to determine if shortening the timeframe for reporting employer/payer information would be feasible, and, if so, if that change would improve the IRS’ ability to reduce the occurrence of erroneous tax refunds being issued based on individuals e-filing fraudulent returns. For example, employers have until March 31 to e-file Forms W-2 data with the SSA. It could be determined that these returns could be filed sooner, for example, February 15. However, IRS should note that Forms 1099 are unlikely to be able to be filed more quickly due to information gathering and processing issues related to Forms 1099.

5. IRS should work with stakeholders in the payer and information reporting communities to assess if a reduction to the threshold of returns required for e-filing would be helpful in reducing instances of fraudulent tax refunds. IRPAC recognizes that any such change would likely require a legislative change. Currently, employers and payers issuing more than 250 Forms W-2 are required to file electronically with the SSA. IRS should evaluate whether lowering this limit would reduce fraud. A change to the limit below 50 Forms W-2 would likely have an adverse taxpayer burden impact on small business. Even a less dramatic reduction could have a negative impact. IRS should work with SSA to increase the number of Forms W-2 that employers can file free of charge through the SSA website from the current limit of 20 forms to a greater number, e.g., 50 forms.  Such a change might be helpful since we understand that there has been a greater incidence of fraudulent returns and reporting errors with paper Forms W-2. Currently, approximately 40 million Forms W-2 are filed on paper. IRS should also encourage its stakeholders who are software vendors working with Form W-2 filings to enhance output files sent to SSA to enable more seamless filing of Forms W-2.  These suggestions are aimed at addressing the concern that employers, especially small business, could be impacted with increased burden if the threshold was lowered.

6. IRS should work with SSA to assess how changes to reporting between the two agencies could be made that will help reduce fraud while not increasing taxpayer burden.

7. IRS should consider if receipt of a simple data file for Form W-2 verification could be helpful in reducing the number of fraudulent tax refunds.  The suggestion is that the employer could, at the employer’s option, send a stripped file to IRS (Name, SSN, and EIN) to allow the IRS to verify the existence of the Form W-2 prior to issuance of a refund.  The suggestion is that the employer could issue this stripped file annually in early January to IRS (the file would not include wage and tax information).  The return to the employer of sending this file is that the IRS would not contact the employer via phone or fax requests for individual Form W-2 verification.

8. Alternatively, employer could, at the employer’s option, send a duplicate file to IRS (in the same format and at the same time as sent to SSA) for verification only. This would allow IRS to verify the W-2 prior to issuance of any refund. The return to the employer would be that it would eliminate IRS contacting via phone or fax requests for Form W-2 verification after file was received. Currently, some employers are doing this with IRS. However, this may not be especially helpful since the employer filing to SSA is currently not required until March 31.

9. IRS should work with stakeholder groups to determine additional algorithms of data combination, and situations that, if reported on a Form 1099 or Form W-2, could suggest that there is a fraudulent return. IRS’ systems could be programmed to catch such potential problems and avoid issuing a fraudulent tax refund. Review with stakeholder groups might alert IRS to situations that IRS had not previously contemplated.

Discussion

Employers are required by law to file Forms W-2 to the SSA by February 28 following the close of the tax year. The filing deadline is March 31 if the employer e-files these Forms W-2 to the SSA. The SSA processes the data and performs a number of edit and validation routines to scrub and perfect the data to ensure that the data is as accurate as possible prior to posting the individual records to the SSA’s database and before passing the data to IRS. IRS starts receiving Form W-2 data weekly from SSA in January following the close of the tax year, but most of the data is not received until March or April. The timing of when the data is available to IRS for use in field audits is key to IRS being able to identify potentially fraudulent Forms W-2 prior to issuance of an erroneous tax refund.

Employer/payer and individual filing due dates and filing requirements are set by law.  Employers and payers have established business processes and systems geared to compliance with these legal requirements. U.S. taxpayers are accustomed to filing individual tax returns by April 15 and many are accustomed to filing as early as possible (e.g., in early to mid-January) in order to obtain their tax refunds as quickly as possible.

IRPAC understands that the problem with issuance of fraudulent tax refunds should be addressed. However, many stakeholders may be affected by changes aimed at reducing fraudulent tax refunds. Changes that would impact employer/payer responsibilities, business processes, and systems, and changes that would impact individual taxpayers’ early receipt of their refunds are major changes that would require thorough exploration with stakeholder groups and evaluation of the costs and benefits of any such change. IRPAC welcomes the opportunity to work with IRS on these important issues. We note that this issue should also be considered as the Commissioner’s vision of real-time returns is studied.

N. TIN Masking on Payee 1099s

Recommendation

IRPAC recommends that the optional TIN masking pilot program set forth in Notice 2009-93, and extended in Notice 2011-38, be made permanent, and expanded to cover:  (1) other types of payee statements (including Forms 3921, Exercise of an Incentive Stock Option Under Section 422(b), 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Section 423(c),and  W-2 (although we understand that a statutory change is required for this change), (2) electronically furnished payee statements, and (3) truncation of a payee's EIN.

Discussion

Please see IRPAC's 2010 Report and our comment letter dated December 17, 2009, for additional information.

Page Last Reviewed or Updated: 11-Mar-2014