As a result of a U.S. Internal Revenue Service (IRS) Revenue Ruling issued in July 2008, U.S. employers maintaining retirement plans tax-qualified both in the United States and in Puerto Rico (dual-qualified plans) should consider splitting those plans into separate U.S.-only and Puerto Ricoonly qualified plans.

The tax advantages available to Puerto Rico-based employees upon distribution from a Puerto Rico-only qualified plan may be reason enough for many employers to choose a Puerto Rico-only plan. However, dual-qualified plans can also be challenging for employers to maintain, providing additional incentive for employers to split their plans. The 1 January 2011 deadline for splitting plans without tax penalty makes the decision more pressing on human resources, employee benef its and tax executives at companies maintaining these dualqualified plans.

An employer maintaining a dual-qualified plan cannot transfer the assets and liabilities of that plan to a Puerto Rico-only qualified plan on or after 1 January 2011, without triggering taxation of the U.S.-source income portion of the transferred assets and potential U.S. tax disqualification of the plan making the transfer. Under the ruling, the IRS provided limited transition relief permitting transfers from dual-qualified plans to Puerto Rico-only qualified plans prior to 1 January 2011, without triggering these taxation and disqualification problems.

Employers maintaining dual-qualif ied plans are not required to make these transfers. Instead, they may continue to maintain dual-qualified plans after the expiration of the transition period. However, these employers should consider the challenges— for both employers and employees—of working with dual-qualified plans.

Challenges for the Employer

An employer maintaining a dual-qualified plan faces a number of challenges:

  • Duplicate non-discrimination testing requirements under separate U.S. and Puerto Rico tax laws
  • Duplicate tax withholding, reporting and disclosure requirements under separate U.S. and Puerto Rico tax laws

Separate timing, data gathering, paperwork and communication rules further complicate the administration of dual-qualified plans for employers. Moreover, duplicate relationships often must be maintained with both U.S. and Puerto Rico advisors and service providers, such as trust or custodial companies and plan record keepers. This leads to additional expense and increased potential for administrative error in monitoring their overlapping duties.

Challenges for Employees

Employees also can be unfavourably affected by special tax laws that apply to dual-qualified plans:

  • Unfavourable double taxation and withholding on earnings that accrue in the retirement plan by both the United States and Puerto Rico when distributions are made
  • Unfavourable tax laws that restrict flexibility for employees in rolling over their retirement distributions from a dual-qualified plan

Acting Before End of Transition Period

By separating a Puerto Rico-only plan from a dual-qualified plan, an employer can avoid these complexities. Therefore, employers maintaining dual-qualified plans may wish to consider using the transition relief provided by the IRS and splitting those plans into separate U.S.-only and Puerto Rico-only qualified plans before 1 January 2011.

Splitting the plans requires that a number of steps be taken. These can take a significant amount of advance planning and scheduling, so companies interested in splitting their plan should begin contacting their lawyers, trustees and other service providers as soon as possible so that they are not too late to make a smooth, favourable and cost-effective transition in separating their plans. Other considerations can also affect the decision to discontinue maintaining a dual-qualified plan, and every employer’s situation is different. Companies maintaining dual-qualified plans should consult with their legal advisors in considering whether a separate Puerto Rico-only plan is more effective in meeting their needs and the needs of their employees