On September 27, 2010, the Small Business Jobs Act of 2010 (HR 5297) (Jobs Act) was signed into law by President Obama. While the law was primarily focused on certain small business tax incentives, several of the provisions changed the rules applicable to certain fringe benefits and elective deferral retirement plans (401(k), 403(b) and 457(b) governmental deferred compensation plans).

Relaxed Documentation for Employer-Provided Cell Phones and PDAs

The Jobs Act removes employer-provided cell phones from the statutory definition of "listed property" under Internal Revenue Code Section 280F(d)(4) beginning January 1, 2010. Tangible property identified as "listed property" is subject to strict substantiation requirements and less favorable tax depreciation rules. Under prior law, in order to have cell phone use considered a business expense (not taxable to an employee), the IRS required records to be kept that substantiated the value of the cell phone use, the time and place the phone was used, the necessary business purpose, and the business relationship of the person using the phone to the employer.

Although the above strict substantiation requirements have been eliminated for employer-provided cell phones, the right to develop rules of convenience for determining whether employer-provided cell phones are either a working condition fringe benefit or a de minimis fringe benefit (i.e., where calculating the personal use costs is administratively impracticable) still ultimately lies with the Internal Revenue Service. Last year the IRS issued Notice 2009-46 asking for employer comments and suggestions for valuing employee personal use of cell phones. We expect additional guidance to be issued by the IRS on both of these issues—tax exclusion and valuation of compensatory use.

Roth Conversions Now Permitted in Employer Based Plans

Prior legislation adopted a rule allowing taxpayers to make Roth IRA conversions during 2010 of amounts distributed from regular IRAs and qualified retirement plans (either post-termination retirement or in-service withdrawals). The Jobs Act expands the Roth conversion rules for 2010 and beyond to allow in-service conversion under the plan of amounts in a participant's pre-tax accounts otherwise eligible for distribution to the participant's Roth (post-tax) account within the qualified plan. Plans eligible to offer this provision include 401(k), 403(b) and, for years after 2010, Section 457(b) governmental retirement plans. In order to adopt the provision, the elective deferral plan must have a Roth deferral account established under the terms of the plan. A previous or contemporaneous amendment adding this feature would be required. Ultimately, an additional plan amendment will be required to implement the in-service Roth conversion option. However, the legislative history indicates that the IRS is to provide for an extended remedial amendment period to adopt the formal amendment, hopefully allowing plan sponsors to implement this provision as soon as possible to take advantage of the 2010 special tax provisions discussed below.

Amounts converted from pre-tax retirement accounts into the Roth account are included in the participant's taxable income, but are not subject to the 10% premature withdrawal penalty even if the amounts are converted before age 59 1/2. Similar to the Roth IRA conversion special one-time tax-spreading opportunity, the in-service Roth conversion rules allow the income attributable to amounts converted during 2010 to be included in income 50% in 2011 and 50% in 2012. Thereby spreading the taxes on the conversion over the next two years. Earnings on Roth accounts that satisfy certain holding requirements may be withdrawn income-tax free as a qualified Roth distribution.

Amounts that may be eligible for conversion during 2010 or later would include:

  • 401(k) or 403(b) elective deferral accounts after age 59 1/2.
  • Employer non-safe harbor matching or profit-sharing contributions if pre-tax amounts are subject to an in-service withdrawal election.
  • Amounts rolled over from a prior employer's plan, if such amounts are distributable under the plan.

Advantages of electing the in-plan Roth conversion, as opposed to a direct Roth IRA conversion, include the possibility of greater creditor protection and continued access to the Roth amounts via participant plan loans. However, there are potential drawbacks as well. First, converted amounts in the qualified plan continue to be subject to required minimum distributions (post age 70 1/2), whereas Roth IRAs are exempt from these requirements. Any Roth IRA contribution begins the five-year holding period for all Roth IRAs owned by the account holder. There is a separate five-year holding period for in-plan Roth conversions that must be met before a participant can receive earnings on distributions from the in-plan Roth accounts. Separate accounts within the employer's plan for Roth deferrals or rollovers and the new Roth in-plan conversion amounts are recommended. This will allow the converted in-plan amounts and earnings to be differentiated from deferrals or rollovers should any premature (taxable) distributions occur.

Before offering a Roth conversion option to employee participants, plan sponsors need to confirm with their third-party administrators and other vendors a) whether the plan provides a Roth deferral account; b) whether the vendors can administer an in-plan transfer and Roth conversion; and c) the administrative requirements that must be satisfied before the provisions could be added to the plan. Because of the number of unanswered questions relating to the in-plan conversions, some employers may find that vendors are not prepared to allow the conversions in 2010. .