2014 IRPAC Public Report: Employee Benefits and Payroll Subgroup
A. Third-party Sick Pay Reporting
1. In our 2013 Public Report, IRPAC recommended the IRS create a way to accept third-party sick pay recap reporting since the current process of reporting to the Social Security Administration (SSA) will end when SSA implements its new Wage Reporting System in 2014. The IRS has created the new Form 8922, Third-Party Sick Pay Recap, and will accept paper recap forms for tax year 2014 filed in 2015.
2. IRPAC recommends that IRS continue to work with IRPAC on all third party sick pay reporting issues.
3. IRPAC requests that the IRS create an electronic version of the new form for the 2015 filing season.
IRS worked with IRPAC on the paper receipt of new Form 8922 and IRPAC will continue to work with IRS on the electronic filing of the form as well as any processing issues that may arise with this new form and the new way to report recaps.
Many employers use third party sick pay providers to furnish and file Forms W-2, Wage and Tax Statement, for short-term and/or long-term disability payments. It is very common under these arrangements for the employer and third party to agree to split the responsibilities for tax depositing and reporting Forms 941, Employer’s Quarterly Federal Tax Return and Form W-2, Wage and Tax Statement, in such a way that a Third-Party Sick Pay Recap W-2 and W-3, Transmittal of Wage and Tax Statements, must be filed by one party to reconcile its Forms 941, with its Forms W-2. Reporting directly to the IRS will be more effective and efficient compared to the historic process of reporting to the SSA that, in turn passes the information over to the IRS.
B. Basis Allocation for Direct Rollovers to IRAs under IRC § 402(f)
1. IRPAC would like to thank the IRS for adopting our recommendation to provide consistent basis allocation rules for direct and indirect rollovers from qualified retirement plans. IRPAC first provided a formal recommendation on this issue in our 2010 Public Report, followed by multiple discussions with IRS personnel in 2012 and 2013.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) expanded the rollover provisions to permit the rollover of after-tax amounts (directly and indirectly), and expressly provided in the flush language of IRC § 402(c)(2) that the amount transferred shall be treated as consisting first of "the portion of such distribution that is includible in gross income." The legislative history similarly stated that "if a distribution includes both pretax and after-tax amounts, the portion of the distribution that is rolled over is treated as consisting first of pretax amounts." Accordingly, plan sponsors and third party administrators have historically permitted a participant to directly or indirectly roll over the entire pre-tax amount first. For example, if the participant took a full distribution of $10,000 of his account, which had $2,000 of after-tax contributions and the remainder as pre-tax amounts, the participant could elect to rollover the entire $8,000 pre-tax amount to a traditional IRA and the remaining $2,000 to be paid in cash (or rolled to a Roth IRA) to the participant tax-free.
An updated model 402(f) (rollover notice) was issued in late 2009 (Notice 2009-68, Safe Harbor Explanation — Eligible Rollover Distributions) that challenged this approach. The Notice states that if the distributee elects to rollover only a portion of the distribution in a direct rollover, an allocable portion of any after-tax contributions are considered rolled over.
With the release of Notice 2014-54, the IRS has reunified the treatment of basis allocation for direct and indirect rollovers, which will simplify tax planning for retirees, tax administration for retirement plan administrators, and provide ease of administration for the IRS.
C. Proper Reporting of Flexible Spending Arrangement Overpayments
1. IRPAC requested the IRS issue correction procedures for improper Health Flexible Spending Arrangements (FSA) payments by Third Party Administrator (TPA). When an employer hires a TPA to run an FSA program and pay the reimbursements and the TPA discovers an error has been made in making a reimbursement to a participant which cannot be offset by other proper payments (e.g., ineligible expenses, insufficient receipts), the participant should be treated as having taxable income.
IRPAC requested guidance/clarification on how and when the taxable income is reportable. The Office of Chief Counsel released a Memorandum on March 28, 2014 describing the correction procedure for improper FSA payments.
IRPAC thanks the Office of Chief Counsel for publishing guidance along with law and analysis. The Memorandum will facilitate compliance.
D. Patient Protection and Affordable Care Act and Health Reimbursement-like plans
1. IRS should clarify that non-health reimbursement arrangement (HRA) integrated plans are not required to satisfy the lifetime and annual rules on a stand-alone basis, provided that the combined benefit satisfies the requirements.
The Patient Protection and Affordable Care Act (ACA) prohibits group health plans from imposing lifetime and annual limits on the dollar value of essential health benefits, but allows “restricted annual limits” for plan years beginning before January 1, 2014. The preamble of the Interim Final Rule on lifetime and annual limits (26 CFR 54.9815-2711T) distinguishes between stand-alone HRAs and HRAs that are integrated with other group health coverage. The preamble states that when an HRA is integrated with other health coverage, if the other coverage alone would meet the lifetime and annual limits requirements, the HRA need not satisfy the requirement on its own because the combined benefit satisfies the requirements.
There are non-HRA plans that are integrated with other health coverage that satisfy the lifetime and annual limit rules. These non-HRA plans do not permit unused portions of the maximum dollar amount to be carried forward to increase the maximum reimbursement amount in subsequent coverage periods. These plans should be given the same treatment as integrated HRAs for purposes of the lifetime and annual limit rules. IRPAC wishes to commend the IRS for publishing Notice 2013-54 wherein they consolidate the Affordable Care Act, HRAs, Health FSAs and certain other Employer Healthcare Arrangements with Department of Labor. More information is available at FAQs about Affordable Care Act Implementation Part XI.
E. Withholding and reporting for pension payments to Nonresident Aliens
1. IRPAC recommends that the IRS clarify the withholding requirements in cases where retirement plan participants, who are nonresident aliens (NRAs), complete in-plan Roth rollovers. While the IRS provided clear guidance that withholding is not required on the in-plan Roth rollover transaction for US persons, it is unclear to plan administrators and payors what withholding requirements, if any, apply to these transactions for NRAs. Recent modifications to the in-plan Roth rollover rules (found in Notice 2013-74) create further uncertainty, as the IRS indicated that funds not eligible for distribution from the retirement plan can now be included in an in-plan Roth rollover.
2. IRPAC also recommends that the IRS expand the list of “Income Codes” reported in box 1 of Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, to allow for more accurate reporting of pension income and potentially prevent lost tax revenue.
Withholding on in-plan Roth rollovers
In-plan Roth rollovers became effective for distributions made after September 27, 2010, and permit a plan that includes a qualified Roth contribution program to allow employees to roll over pre-tax amounts from their accounts to their designated Roth accounts in the plan. To be eligible for an in-plan Roth rollover under Small Business Jobs Act of 2010 (SBJA) § 2112, the amount had to satisfy the rules for distribution under the Code (an “otherwise distributable amount”) and had to be an eligible rollover distribution as defined in § 402(c)(4). Section 902 of The American Taxpayer Relief Act of 2012 (ATRA) added § 402A(c)(4)(E) to the Code to expand the type of amounts eligible for an in-plan Roth rollover. IRC § 402A(c)(4)(E) provides that the in-plan Roth rollover of these additional amounts (“ otherwise nondistributable amounts” ) will not be treated as violating the statutory distribution restrictions applicable to elective deferrals.
In Notices 2010-84 and 2013-74, the IRS provided clear guidance that the mandatory 20% withholding found in IRC § 3405 does not apply to an in-plan Roth direct rollover, noting specifically that some or all of the rollover amount may not be eligible for distribution under the terms of the plan. However, the IRS did not address whether or not the mandatory 30% withholding found in IRC § 1441 applies to an in-plan Roth direct rollover. If the IRS believes that IRC § 1441 withholding does apply, then IRPAC believes that the IRS must issue additional guidance to inform payors of the requirement to withhold and to reconcile how payors can withhold tax on in-plan Roth direct rollovers when some or all of the rollover amount is not eligible for distribution from the plan. Note that if withholding is required on this transaction, additional guidance will also be needed to clarify how payors should report the transactions on Form 1042-S.
Expanding “Income Codes” on Form 1042-S for pension distributions
Payors report pension distributions to US persons on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., which has a “Distribution Code” scheme in box 7 that allows the payor to communicate information about the nature of pension distribution to IRS. Important examples include whether or not a distribution is “early” and subject to the early withdrawal penalty or when a distribution is a nontaxable direct rollover.
Form 1042-S, which among other things, is used to report pension income to foreign persons, has no corresponding coding system for pension distributions. Currently the only way for a payor to communicate that a distribution is from a pension is by using “Income Code -14” in box 1. That single income code is used for all pension distributions, meaning that pension payors have no mechanism to indicate to the IRS or the foreign plan participant that the pension distribution is “early” and subject to the 10% penalty. Without this information, the IRS and foreign plan participants may be unable to determine when an early distribution penalty applies, potentially leading to lost revenue for the IRS.
IRPAC believes that the IRS could close this gap by expanding the list of “Income Codes” to include several variations on Income Code “14 – Pensions, annuities, alimony, and/or insurance premiums”.
IRPAC provides the following list of suggested additional “Income Codes” for box 1 on Form 1042-S:
52 - Pension or annuity - early distribution
53 - Pension - taxable Roth conversion or rollover
54 - Pension or annuity - direct rollover
55 - Pension - nontaxable Roth distribution
56 - SIMPLE IRA - early distribution in first 2 years
F. ACA Education Using Plain Language and Education
1. The ACA Information Center for Tax Professionals page on the IRS website should be improved to provide clearer guidance about what constitutes minimum essential coverage (MEC).
2. Special emphasis should be placed on explaining in the forms and instructions a unique 2014 issue where no information reporting will exist and confusion about MEC is very likely.
Tax professionals will be confused about what type of documentation to accept in preparation of individual income tax returns for 2014 regarding MEC. The chart on the IRS webpage about the individual shared responsibility provision lists 28 examples of differing types of health insurance coverage. IRPAC commends IRS for the detailed listing of coverages and the work that was involved in the listing. The difficulty will be for taxpayers to match the type of coverage from the list to the coverage they have. This is especially true for the examples of coverages with references to special federal laws. Combining the complexity of tax rules together with the complexity of understanding health insurance creates a near perfect storm for taxpayers and tax professionals.
The confusion will be most pronounced for 2014 since the individual shared responsibility provision of IRC §5000A is new for 2014. The information reporting rules of IRC §§6055 and 6056 have been delayed for one year with reporting first required for 2015. For years after 2014 this confusion will be mitigated with new information returns 1095-B, Health Coverage, and 1095-C, Employer Provided Health Insurance Offer and Coverage, reporting who has MEC and for what period of time during the year.
Early release drafts of Form 1095-B and 1095-C were issued as “DRAFT AS OF JULY 24, 2014”. Early release draft instructions were issued as “DRAFT AS OF AUGUST 28, 2014.” On August 29, 2014, IRS released Questions and Answers on Information Reporting by Health Coverage Providers on IRS.gov. Voluntary reporting on these forms has been encouraged for 2014 but is being hampered by the timing of final forms and instructions.
IRPAC considered various recommendations and found no perfect sources of information to be used in advance of the requirements to provide Forms 1095-B and 1095-C for 2015. We reviewed documents entitled “New Health Insurance Marketplace Coverage and Your Health Coverage,” the “Summary of Benefits and Coverage,” a typical insurance identification card and other non-governmental documents. The Summary of Benefits and Coverage does require a statement about MEC starting in 2014. However, none of the documents examined contained all of the information necessary to conclude that MEC exists for the responsible person and all covered individuals for all months during 2014.
In order to assist taxpayers and tax professionals for 2014 IRPAC recommends that special emphasis be placed in instructions on the most common coverage types, and common types of documentation acceptable as proof of coverage for 2014.
G. Reporting by insurance companies and third parties under IRC §§6055 and 6056
1. IRPAC recommends that instructions for line 61 of Form 1040, U.S. Individual Tax Return, discuss the importance of providing social security numbers for responsible and covered individuals to insurance companies and employers as well as the consequence of not providing social security numbers. During 2014 IRPAC shared with the IRS suggested “Questions and Answers” on this subject and recommended that similar information be shared in form instructions and on the IRS website.
2. The 2013 IRPAC Report stated that “IRPAC recommends that the IRS issue Taxpayer Identification Number (TIN) solicitation requirements and procedures for purposes of satisfying reporting under §§6055 and 6056 and that IRS explain these rules in plain language on the IRS webpages designed for individuals.” In 2014, IRPAC recommended (Appendix B) that the 2014-2015 Priority Guidance be expanded to include new or revised regulations under IRC §§6055 and 6056 which address unique new solicitation issues. These recommendations continue to be relevant today.
3. The 2013 IRPAC Report noted the need for adequate transition rules to implement these new reporting rules. IRPAC recommends that IRS expand the time period for voluntary compliance with IRC §§6055 and 6056 from 2014 to 2015 and provide general transition relief for 2015.
1. IRC §§6055 and 6056 impose new information reporting rules on insurance companies and employers. These rules were initially to apply for 2014 but were delayed by Notice 2013-4, 2013-31 I.R.B.116 until 2015. Insurance companies have taken steps to secure social security numbers of customers. Employers are taking similar steps for dependents of their employees who are covered individuals. Insurance companies report mixed success in ongoing efforts to secure missing social security numbers.
New Forms 1095-B and 1095-C will be used by the IRS to verify compliance with the individual shared responsibility provision on income tax returns. Insurance companies and employers will electronically provide this information to IRS for matching against filed individual income tax returns. Electronic information provided to IRS without social security numbers will be difficult to match effectively and likely result in correspondence from IRS asking taxpayers to verify coverage. The correspondence from IRS asking taxpayers to verify coverage may be expected to do little to work toward one part of the Strategic Goals of the IRS for 2014-2017 to “deliver high quality and timely service to reduce taxpayer burden and encourage voluntary compliance.” Voluntary compliance could actually suffer from unnecessary and scant IRS resources being utilized to verify compliance which have to be diverted from other priorities with higher potential for noncompliance.
The 2013 IRPAC Report noted, “Insurers anticipate resistance from insured individuals in obtaining TINs and are seeking assistance from the IRS in educating the public about the need to provide an accurate TIN in a timely manner.” This resistance can be mitigated in part where insurers and employers can point customers and employees toward explanations on the IRS website or in tax publications or instructions about the need to provide SSN for these new rules as well as the likely consequences of failure to provide the information.
During 2014, IRPAC shared with the IRS suggested “Questions and Answers” which would assist taxpayers in understanding their responsibility to provide TINs to insurance companies and employers as well as the consequences of not providing this information and recommended that similar information be shared in form instructions and on the IRS website.
2. Public Law 111-148 added IRC §§ 6055 and 6056 to the definition of information returns. IRC §§ 6721 and 6722 impose penalties for failure to include all information or incorrect information on information returns. IRC §6724 provides that no penalty may be imposed if any failure is due to reasonable cause and not willful neglect. TIN solicitation rules for acting in a responsible manner are described in Treas. Reg. 301.6724-1(d) and the rules for missing TINs are described in Treas. Reg. 301.6724-(1)(e). The required manner of making solicitations includes a requirement that payees must be informed that they may be subject to a $50 penalty imposed by the Internal Revenue Service under §6723 if they fail to provide a TIN. Insurance companies report significant questions being raised when notification is made to customers about this penalty.
The 2013 IRPAC Report recommended that these rules be explained in plain language. IRPAC commends the IRS for the efforts to simplify these rules in the preamble to the final regulations and for consideration and reference to many of the comments received. However, as stated in the preamble “Treasury and the IRS recognize that the existing solicitation rules under IRC § 6724 may not address certain circumstances that may arise with respect to reporting under IRC § 6055. Although the final regulations do not revise the regulations under IRC § 6724 to specifically address these circumstances, Treasury and the IRS will continue to study the issue and may provide additional clarification if appropriate through guidance or forms or instructions.”
On May 24, 2014, IRPAC provided recommendations that various items be included in the 2014-2015 Priority Guidance Plan. Recommendation number six from that letter stated that: “Additional clarifications should be issued in the form of new regulations under IRC §6055 which explain the timing and manner of TIN solicitation unique to IRC §6055. Specifically, it is critical to clarify that an enrollment form required to be reported under IRC §6055 is an initial solicitation. This clarification would address the situation of a customer having completed an enrollment form without a TIN many years prior to enactment of IRC §6055.
In addition, new regulations under IRC §6055 should be constructed so that health insurance companies may rely upon solicitations performed by the sponsor of an employer-sponsored group health plan, in order that duplicate efforts to obtain TIN’s can be avoided.”
These recommendations regarding the solicitation process continue to be relevant today.
On August 29, 2014, IRS released Questions and Answers on Information Reporting by Health Coverage Providers on IRS.gov. This guidance should be reworded where it states, “the reporting entity must make the initial solicitation at the time the relationship with the payee is established.” If the relationship was established many years ago or in a state which prohibited the insurer from requesting or collecting the SSN’s it is very likely that a SSN would not have been obtained at the time the relationship was established. Use of the term payee should also be reconsidered because its use in reference to an insurance company or others required to report under these rules is confusing.
IRPAC also recommends that additional guidance be provided to simplify the burden placed on insurers and employers by providing that a solicitation for missing TIN’s may be made at the same time as any Form 1095-B or 1095-C is issued.
3. Early release drafts of Form 1095-B and 1095-C were issued as “DRAFT AS OF JULY 24, 2014”. Early release draft instructions were issued as “DRAFT AS OF AUGUST 28, 2014.” Software vendors and insurance companies and employers are likely reluctant to make major programming efforts until final forms are issued with final instructions. The 2013 IRPAC Report recommended “an 18-month lead-time for new reporting forms or extensive changes to existing forms”
The preamble to the final regulations encourages voluntary compliance with these rules for 2014 by stating “Real world testing of reporting systems and plan designs, built in accordance with the terms of these final regulations, through voluntary compliance for 2014 will contribute to a smoother transition to full implementation for 2015.”
IRPAC believes that substantial voluntary compliance for 2014 is unlikely given the late release of final forms and instructions. Therefore, real world testing of reporting systems and designs cannot be anticipated to achieve the desired results in 2014. Consistent with our prior 18-month lead time recommendation from 2013, IRPAC recommends that the voluntary compliance period be extended to 2015 reporting in 2016 and that general transition relief also be extended for 2015 reporting done in 2016.