Retirement Plan Changes: Small Business Job Protection Act of 1996 and Health Insurance Portability and Accountability Act

Small Business Job Protection Act of 1996 and Health Insurance Portability and Accountability Act

The Small Business Job Protection Act of 1996 (the "'96 Tax Act"), signed into law on August 20, 1996, contains a number of retirement plan amendments designed primarily to simplify the rules relating to retirement plans and increase access to retirement plans. Although some of the changes offer welcomed relief, there are many delayed effective dates. In addition, the '96 Tax Act and the Health Insurance Portability and Accountability Act of 1996 ("HIPAA") made changes to the rules affecting IRAs. The more significant retirement plan provisions of the '96 Tax Act and HIPAA are summarized below.

The '96 Tax Act provides that any plan amendments reflecting changes required by the Act will not need to be made until 1998 (the year 2000 for governmental plans.) Plans must, however, be administered in accordance with the required provisions.

I. SIMPLE (Savings Incentive Match Plan for Employees): Retirement Plan for Small Businesses

1. SIMPLE Retirement Plan. The '96 Tax Act creates a new type of simplified retirement savings vehicle for small businesses and offers an alternative to a qualified 401(k) plan. SIMPLE plans do not need to meet many of the requirements applicable to qualified plans, however, they permit a current deduction to the employer and the contributions are not taxable to the employee until withdrawn.

   Who May Adopt.

   A SIMPLE plan may be adopted by an employer that has fewer than 100 employees who earned more than $5,000 during the preceding year. The employer may not maintain another qualified retirement plan. A SIMPLE plan may cover self-employed; it must cover leased employees. An employer can continue a SIMPLE plan for up to two years after it ceases to be eligible.

   How it Works.

   Eligible employees may elect during a 60-day period before the beginning of the plan year to have salary deferral contributions made to the plan. (The IRS has waived the 60-day notice-to employees election requirement for plans which become effective January 1, 1997.) The deferral must be expressed as a percentage and may not exceed $6,000 for the year (subject to cost of living increases, but only in increments of $500). Compensation is W-2 income plus elective deferrals.

   Employees must be able to elect out at anytime during the year, however, the plan can limit reentry to the first day of the next plan year.

   Matching Contributions.

   The company must generally make a 100% matching contribution to the plan equal to 3% of compensation (but not to exceed the $6,000 limit on elective deferrals). The company can reduce the matching contribution but only if all employees are notified before the 60-day election period for the plan year provided the match does not drop below 3% for more than two out of the five-year period ending with the year in question. As an alternative, the company can elect to make a nonelective contribution of 2% for all eligible employees (whether or not they elect to defer) provided the company notifies the employees prior to their 60-day election period. Nonelective contributions are subject to the 401(a)(17) limit on compensation ($160,000 for 1997).

   Funding Vehicle.

   A SIMPLE plan uses an IRA (including individual retirement annuity) which may only receive SIMPLE plan contributions. The company can limit the IRA provider to a single institution but only if employees are advised that they can transfer their account penalty free to another IRA. Employees are always 100% vested.

   Eligible Employees.

   Any employee who earns more than $5,000 (during either of prior two years and expected to for current year) must be eligible to participate. A SIMPLE plan may exclude union employees, air pilots and nonresident aliens not receiving U.S. source income.

   Administrative Requirements.

   Contributions must be made within 30 days of the last day of the month for which contribution is to be made; matching contributions can be made by the tax return filing date. (ERISA requires these contributions to be made as of the earliest date the contributions can reasonably be segregated from the employer's general assets.) Each year for the 60 days before the calendar year (or 60 days before initial eligibility) the employee may elect to defer or change prior elections. Employees must be given a notice of the opportunity to make salary reduction contributions and the notice must include a summary plan description.
   
   Early Withdrawals.

   Withdrawals prior to age 59 1/2 from a SIMPLE plan are taxed under the rules applicable to IRAs, generally subjecting the withdrawal to a 10% penalty. This 10% penalty is increased to 25% for withdrawals within the first two years of a SIMPLE plan.

   SIMPLE 401(k) Plan.

   A SIMPLE plan can be adopted as part of a 401(k) plan. In that case, the plan does not need to meet the special elective deferral tests or the top heavy rules.

   Effective. SIMPLE plans are effective January 1, 1997 and they replace "SARSEPs" (salary reduction simplified employee pension plans) which may not be adopted after 1996.

2. IRS Model Plan. The IRS has recently issued a model plan, Form 5305-SIMPLE, which employers may utilize to adopt a SIMPLE plan. Employers are not, however, required to use the model plan.

II. Changes for 401(K) Plans

1. ADP and ACP Tests Based on Prior Year. Under the new law the ADP and ACP tests are performed based on the elective deferrals and contributions for the non-highly compensated employees for the plan year preceding the plan year being tested, rather than those made for the testing year. An employer may elect to use data for the testing year, rather than the preceding plan year, but if the employer makes this election, it may only be changed as provided by the IRS.

   For a plan's first plan year, the ADP of non-highly compensated employees shall be deemed to be 3% for the preceding plan year, unless the employer elects to use the actual ADP for the first plan year. A similar rule applies for the ACP test.

   Effective. Years beginning after December 31, 1996.

   Suggested Action. Employers will need to amend their plans for these new definitions. In administering their plans, they will need to use the old definitions for the 1996 plan year. Beginning with the 1997 plan year, however, they will be able to use the amended definitions. This will allow calculation of the ADP and ACP tests earlier in the year, so the administrator will be able to determine the amount of deferrals and matching contributions which can be made by and on behalf of the highly compensated employees.

2. Excess Contributions Returned First to HCE with Largest Contribution. Excess contributions and excess aggregate contributions must be returned to highly compensated employees to satisfy the ADP and ACP tests. Under the new law, the excess amounts must be returned on the basis of each highly compensated employee's contribution (largest contribution first), rather than basing the returned amounts on the employee's deferral or contribution percentage. The old rules generally penalized the lower paid, highly compensated employees ($70,000 to $90,000) who were trying to maximize their deferrals.

   Effective. Years beginning after December 31, 1996.

   Suggested Action. Clients will need to amend their plans to provide for the new method of returning excess contributions and excess aggregate contributions. Beginning with the 1997 plan year, a greater portion of the excess contributions will be returned to the highest paid, highly compensated employees who make maximum deferrals. This change should be communicated to the highly compensated employees.

3. Nondiscrimination Safe Harbor for 401(k) Plans. A safe harbor has been created as an alternative to satisfying the nondiscrimination tests for elective deferrals under a 401(k). The safe harbor requires that a 401(k) arrangement satisfy a contribution requirement and a notice requirement.

   The contribution requirement is satisfied if the employer makes a matching contribution to each non-highly compensated employee equal to:

   (i) 100% of the employee's elective contribution, up to 3% of compensation, and
   (ii) 50% of the employee's elective contribution from 3% to 5% of compensation;
   

   and, the matching contribution rate for any elective contribution of a highly compensated employee is not greater than that for any non-highly compensated employee.

   As an alternative to the contribution requirement, if a different matching contribution rate is used than that described above, the matching contribution requirement will be met if the rate of the employer match does not increase as an employee's rate of elective contributions increases, and the aggregate amount of matching contributions at any elective contribution rate is at least equal to the aggregate amount of matching contributions that would be made under the percentage requirements described above.

   The contribution requirement can instead be satisfied by an employer's required non-elective contribution to this or any other defined contribution plan sponsored by the employer. Such contribution must be made on behalf of all non-highly compensated employees eligible to participate in the 401(k) arrangement, regardless of them making an elective or voluntary contribution. The employer must contribute an amount equal to 3% of the employees' compensation.

   The safe harbor contributions described here must be fully vested and are subject to the withdrawal restrictions which apply to elective deferral contributions. Permitted disparity (Social Security integration) rules may not be used in conjunction with this safe harbor, and contributions made under this safe harbor may not be used for the purpose of the permitted disparity rules.

   The notice requirement is satisfied if each employee who is eligible to participate in the 401(k) is provided a written notice of rights and obligations under the 401(k) within a reasonable period before any year. The notice must be accurate, comprehensive and written to be understood by the average employee.
   

   Effective. This safe harbor is not effective until plan years beginning after December 31, 1998.

   Suggested Action. An employer wishing to apply the 401(k) safe harbor, must amend its plan.

4. Safe Harbor for Employer Match. A safe harbor has been created as an alternative to satisfying the ACP test with respect to employer matching contributions, but not employee contributions. The safe harbor requires that the plan must first satisfy the safe harbor for a 401(k) arrangement. In addition, the safe harbor requires that:

   (i) matching contributions may not be made with respect to employee contributions or elective deferrals in excess of 6% of compensation,

   (ii) the rate of matching contribution cannot increase as an employee's contributions or elective deferrals increase, and

   (iii) the matching contributions for a highly compensated employee at a specific rate of employee contributions or elective deferrals may not be greater than that for a non-highly compensated employee.

   
   

   Effective. The employer match safe harbor is effective for plan years beginning after December 31, 1998.
   

   Suggested Action. If an employer wishes to apply the employer match safe harbor, it should amend its plan. Although this safe harbor may help simplify plan administration for some employers, plans that allow voluntary employee contributions will still be required to satisfy the ACP test. Any matching and nonelective contributions in excess of those used to satisfy the safe harbor may be taken into account for the ACP test.

III. Tax-Exempt and Government Employers

2. 401(k) Plans for Tax-Exempt Employers. Tax-exempt organizations, including Indian tribal governments, may now adopt 401(k) plans.
   
   Effective. January 1, 1997.
   
   Suggested Action. Tax-exempt employers who were previously limited to §457 plans should seriously consider adopting a 401(k) plan beginning in 1997.

3. Section 457 Limit. The dollar limit on deferrals under a §457 plan will have that limit ($7,500) indexed for inflation. Changes will only be made in increments of $500.
   
   Effective. January 1, 1997.

4. Trusts for Governmental §457 Plans. Governmental §457 plans will be required to hold plan assets in a trust.
   
   Effective. New plans are immediately subject to the trust requirement, whereas existing plans are not required to establish and fund trusts to hold plan assets until after 1998.
   
   Suggested Action. State and local government sponsors must consider the potential funding requirements imposed on their existing §457 plans beginning after 1998.

5. Section 457 Plan Distributions. Under the new law, a §457 plan may permit in-service distributions if the total amount payable does not exceed $3,500, deferrals have not been made for at least two years and there has not been any prior in-service distribution made.
   
   In addition, a participant under a §457 plan is now permitted a one-time election to defer commencement of benefits that have become payable. This election will not cause the benefits to be taxable to the participant.
   
   Effective. Years beginning after 1996.

6. Length of Service Awards. Plans paying solely length of service awards to volunteers for fire fighting and prevention, emergency medical or ambulance services, are not treated as deferred compensation plans subject to the rules of §457. Also, such payments are not treated as wages for Social Security tax purposes.
   
   Effective. Accruals of length of service awards after December 31, 1996. The Social Security tax change relates to payments received after December 31, 1996.

7. Qualified Governmental Excess Benefit Arrangements. The new law permits state and local governments to maintain excess benefit plans (i.e., plans that provide benefits which cannot be provided under a qualified plan because of the limits imposed on contributions or benefits). These plans will not be subject to the §457 plan limits, but rather such excess benefit plans are treated in the same manner as such plans maintained by private employers.
   
   Effective. Years beginning after December 31, 1994.

8. Excess Deferrals Under 403(b) Plan. Under the new law, each tax sheltered annuity contract (and not just the plan) must contain language limiting deferrals to the deferral limit ($9,500 for 1996). If the limit is exceeded by one contract this will no longer jeopardize the continued qualified status of the entire plan. Also, if the failure to meet the limit is due to a reasonable error, then the 403(b) contract will not be disqualified and only the excess will be taxable to the employee.
   
   Effective. Generally for plan years after 1995. The requirement that each 403(b) contract contain the annual deferral limit is effective the 90th day prior to August 20, 1996.

9. Rural Cooperative 401(k) Plan Distributions. The new laws allow 401(k) plans maintained by a rural cooperative to permit in-service distributions upon attainment of age 59 or for hardship. These plans are now on parity with other 401(k) plans.
   
   Effective. August 20, 1996.
   
   Suggested Action. Any rural cooperative may wish to amend their 401(k) plan to permit hardship withdrawals or in-service distributions after age 59.

10. College Football Coaches' 401(k) Plan. The '96 Tax Act reinstated the qualified status of the American Football Coaches Association's 401(k) plan. A qualified football coaches' plan is treated as a multiemployer, collectively bargained plan and may include a 401(k) feature.
    
    Effective. Plan years beginning after December 22, 1987.

IV. Distributions from Retirement Plans

2. Repeal of 5-Year Averaging. Taxpayers were allowed to pay a separate tax on a lump sum distribution from a qualified plan equal to approximately the tax which would have been due if the distribution had been received in five equal annual installments. Five-year averaging is repealed effective for tax years beginning after December 31, 1999. The '86 Tax Reform Act transition rule for 10-year averaging and capital gains treatment is preserved (limited to taxpayers who had reached age 50 before 1986).
   
   Effective. January 1, 2000.
   
   Suggested Action. Any taxpayer who may be eligible to use five-year averaging before the year 2000 should compare that tax with the tax the taxpayer would otherwise pay to determine whether it makes economic sense to take lump sum five-year averaging.

3. Taxation of Annuity Distributions. The '96 Tax Act provides a simplified method for recovering the nontaxable portion (i.e., basis) of a taxpayer's annuity distributions from a qualified plan, 403(b) plan or 403(a) annuity contract. This new method replaces prior law. Under the new method, the nontaxable return of basis is determined by dividing the investment in the contract (as of the annuity starting date) by a designated number of monthly payments determined by the age of the taxpayer, as follows:
   
   
   • Age
   • Number
   • 55 or younger
   • 360
   • 56 - 60
   • 310
   • 61 - 65
   • 260
   • 66 - 70
   • 210
   • older than 70
   • 160
   
   The number of payments is adjusted if payments are made less frequently than monthly. This new method is similar to the alternative method provided by the IRS in Notice 88-118.
   
   Effective. Applies to annuities with starting dates after November 20, 1996.

4. Suspension of Excise Tax on Excess Distributions. The 15% excise tax on aggregate annual distributions from qualified plans and IRAs in excess of the threshold amount ($160,000 for 1997 or $800,000 for lump sum distributions) is suspended for distributions made during 1997, 1998 and 1999.
   
   Effective.Calendar years 1997, 1998 and 1999.
   
   Suggested Action. Taxpayers subject to the excise tax should consider taking extra distributions while the tax is suspended to avoid the tax (and, by reducing the benefits may reduce the additional 15% estate tax on excess accumulations).

5. Age 70 1/2 Minimum Distributions. Under the new law, a participant, other than a 5% owner, in a qualified plan need not commence distributions until the April 1 of the calendar year following the later of the year in which the participant attains age 70 1/2 or the year in which the participant terminates employment. For those participants who retire after age 70 1/2, the participant's accrued benefit must be actuarial increased to take into account the period during which the participant was not receiving benefits.
   
   Effective. Plan years beginning after December 31, 1996.
   
   Suggested Action . Employers should amend their retirement plans to eliminate mandatory age 70 1/2 distributions to active employees; this will ease plan administration. The plan will need to retain the age 70 1/2 distribution as an elective benefit because the IRS views this as a "protected benefit" which cannot be taken away. Active participants (other than 5% owners) who have attained age 70 1/2 should request that their employer defer in-service minimum distributions until actual retirement.

6. Joint and Survivor Annuity Explanation. Under current regulations, distributions may not be commenced for 30 days following receipt of the explanation and waiver of a joint and survivor annuity. The new law provides that a participant may be permitted to waive the 30 day period as long as distributions don't begin sooner than seven days following receipt of the joint and survivor explanation.
   
   Effective. Plan years beginning after 1996.
   
   Suggested Action. Procedures for administering joint and survivor annuities distributions from qualified plans should be amended.

7. IRA Withdrawals. Currently, most distributions from IRAs made prior to age 59 are subject to a 10% penalty tax. Distributions from a qualified plan for medical expenses in excess of 7 of adjusted gross income are permitted tax free. HIPAA extends this exception to IRA distributions. There is also an exception to the 10% penalty for distributions to certain unemployed individuals to cover health care insurance premiums.
   
   Effective.Tax years beginning after December 31, 1996.

8. Sample Spousal Consent Forms and QDRO Language. Pension plans and certain profit sharing plans are required to provide benefits to married participants in the form of a qualified joint and survivor annuity unless waived by the participant with the consent of the participant's spouse. In addition, there are a number of rules governing payments to a former spouse pursuant to a qualified domestic relations order ("QDRO").
   
   The '96 Tax Act requires that the IRS issue sample language for spousal consent forms relating to the waiver of the joint and survivor annuity benefit and for QDROs.
   
   Suggested Action. Employers should use the IRS approved forms or language when they are made available.

9. Death Benefit Exclusion. The '96 Tax Act repeals the $5,000 death benefit exclusion available to a beneficiary of a deceased employee, including retirement plan benefits.
   
   Effective.Individuals dying on or after August 21, 1996.

V. Reemployed Veterans

2. Break in Service, Vesting and Accrual of Benefits. For qualified retirement plan purposes (including § 457 plans), an individual reemployed under the Uniformed Services Employment and Reemployment Rights Act of 1994 ("USERRA") must not incur a break in service due to "qualified military service", and must be credited with service for each period of "qualified military service" to determine vesting and accrual of benefits.
   
   Effective.December 12, 1994.
   
   Suggested Action. Employers must amend their retirement plans to comply with USERRA by the first day of the plan year beginning on or after January 1, 1998 (Rev. Proc. 96-49 extended the amendment date from October 13, 1996). Employers may adopt the IRS model amendment at anytime before this date. An application for a favorable determination letter will not be required if the employer adopts the model amendment. Employers must operate under this law effective December 12, 1994.

3. "Make-Up" Elective Deferrals, Employee Contributions and Matching Contributions. The employer must allow individuals reemployed under USERRA to contribute "make-up" elective deferrals and after-tax employee contributions, plus make any required matching contributions based on the "make-up" contributions. These individuals are also entitled to accrue benefits during their qualified military service. Earnings may be credited only after the make-up contributions are made. No make-up contribution is required of any forfeitures allocated during the qualified military service.
   
   The new law specifies the period in which the reemployed individual may contribute "make up" contributions. The amount of make-up contributions is limited to the amount which would have been permitted or required had the employee been continuously employed by the employer during the period of qualified military service. For this purpose, compensation will be based on the rate of pay the employee would have received during the qualified military service or, if uncertain, based on an average of the 12-month period preceding the qualified military service.
   
   Suggested Action. See A., above.

4. Annual Additions Limitation. Provisions have been made to allow (i) "make-up" contributions to a plan without regard to the various annual limits on plan contributions and benefits, and contribution deductions, (ii) "make-up" contributions to be made without violation of various plan qualification requirements, and (iii) suspension of plan loan repayment during uniformed service.
   
   Make-up contributions are not taken into account for the year in which they are made for purposes of the following limits: §402(g) elective deferrals, §402(h) SEP, §415 limits for qualified defined benefit or defined contribution plans, §403(b) tax-sheltered annuities, §408 SEP, §457 government/tax-exempt deferred compensation plans, and §404(a) and §404(h) employer deductions. However, make-up contributions are subject to these limitations for the year(s) for which they would have otherwise have been made.
   
   Make-up contributions are not taken into account for either the year made or for the year to which they relate for purposes of the general plan qualification requirements (i.e., §401(a)(4), §401(a)(26), §401(k) nondiscrimination rules, and §410(b)).
   
   Suggested Action. Determine a process to identify "make-up" contributions for reemployed veterans so they will not be counted for plan year limits and nondiscrimination tests. Also, review loan policy to permit suspension of repayments during military service. See A., above.

VI. Tax Qualification Provisions

2. Definition of Highly Compensated Employee. Under the '96 Tax Act highly compensated employees are defined to mean an employee who
   
   1. was a 5% owner of the employer at anytime during the year or the preceding year; or
   
   2. had compensation for the prior year in excess of $80,000 (to be indexed for inflation) and was in the top 20% of employees by compensation for the year.
   
   Effective. Plan years beginning after 1996.
   
   Suggested Action. Employers should amend their qualified plan(s).

3. Repeal of Family Aggregation. The aggregation of family members for discrimination and compensation limitation purposes has been repealed by the '96 Tax Act.
   
   Effective. Plan years beginning after 1996.
   
   Suggested Action. Employers should amend their qualified plan(s).

4. Minimum Participation Rules. For defined contribution plans, the new law drops the minimum participation rule of §401(a)(26) (plan must cover lesser of 40%of all employees or 50 employees). For defined benefit pension plans the rule is modified to require that the plan cover the lesser of:
   
   (1) 50 employees; or
   
   (2) the greater of 40% of all employees or two employees (unless there is only one employee).
   
   Effective.Plan years beginning after 1996.
   
   Suggested Action. Employers should review whether it makes sense to disaggregate defined contribution plans which were previously merged to satisfy the minimum participation rule.

5. Definition of Compensation for Section 415 Purposes. For purposes of the §415 annual limits on allocations to a participant's account under a defined contribution plan or annual benefits under a defined benefit plan, the definition of compensation has been amended to include elective deferrals to a 401(k) plan, §403(b) annuity, §457 plan or a cafeteria plan. This change will greatly simplify the administration and monitoring of defined contribution plan limits.
   
   Effective. Plan years beginning after 1997.
   
   Suggested Action. Employers should amend their plans to modify the definition of compensation for purposes of the §415 limits.

6. Definition of Leased Employee Revised. The current law requires that certain leased employees be treated as an employee for benefit plan purposes. The new law replaces the condition that a leased employee include a worker who is performing services "historically performed" by employees with a requirement that the worker's services be performed under the significant direction or control of the contracting business.
   
   Effective. Plan years beginning after 1996.

7. Repeal of Combined Plan §415 Limit. Currently, employers who maintain both a defined contribution plan and a defined benefit plan must satisfy a combined §415 limit. The new law repeals this limitation.
   
   Effective.January 1, 2000.
   
   Suggested Action. Plans should be amended to delete any reference to the combined limit after 1999.

8. Delayed GATT Actuarial Assumptions. The requirement that GATT interest and mortality assumptions be used to limit benefits payable before age 62 has been retroactively repealed.
   
   Effective.The repeal is effective back to 1994 (the original effective date), and the revised effective date is January 1, 2000. Employers who have adopted conforming amendments can retroactively repeal them.
   
   Suggested Action. Small business owners should consider taking defined benefit pension plan lump sum distributions, especially in light of the suspension of the excise tax on excess distributions (See V.C., above).

VII. ESOPS

2. Repeal of 50% Interest Exclusion. The `96 Tax Act repealed the special 50% income exclusion available to financial institutions for interest income they earned on certain loans made to ESOPs.
   
   Effective. August 20, 1996, with an exception for loans made pursuant to binding commitments in effect before June 10, 1996.

3. S Corporations. The '96 Tax Act allows qualified retirement plans to be an S corporation shareholder. Thus, an S corporation will be able to adopt an employee stock ownership plan (ESOP). For purposes of determining the number of shareholders of an S corporation, a qualified plan is counted as only one shareholder.
   
   A number of special benefits available to ESOPs are not available with respect to S corporation stock held by an ESOP:
   • No deduction is allowed for a contribution to an ESOP by an S corporation.

   • An S corporation may not take advantage of the special deduction for dividends paid on stock held by an ESOP.

   • An S corporation shareholder may not take advantage of the special §1042 tax-free rollover provisions for sales of S corporation stock to an ESOP.
   
   
   Effective.Tax years beginning after December 31, 1997.

VIII. Technical and Miscellaneous Retirement Provisions

2. Homemaker IRAs. For married individuals filing a joint return, the maximum contribution to an IRA for the nonworking spouse has been increased to $2,000.
   
   Effective. January 1, 1997.

3. Multiemployer Plans. The provision permitting multiemployer pension plans to use 10 year "cliff" vesting has been repealed. The vesting rules now conform to the rules applicable to other qualified plans.
   
   Effective. Plan years beginning after January 1, 1997 or, if later, after the collective bargaining agreement termination (but not later than January 1, 1999).
   
   Suggested Action.Multiemployer plans will need to be amended.

4. Retirement Age. The new law provides that notwithstanding its scheduled increases, the Social Security retirement age is a uniform age for general nondiscrimination purposes and for determining whether early retirement or joint and survivor annuities are being made available to employees on the same terms.
   
   Effective. Plan years beginning after 1996.

5. Disabled Employees. An employer may now continue deductible contributions to a defined contribution plan on behalf of all participants who are permanently and totally disabled. Prior law limited this option to employees who were not highly compensated officers or owners.
   
   Effective.Years beginning after 1996.

6. Insurance Company's General Account as Plan Assets. The new law requires guidance is to be issued by the Department of Labor as to whether and to what extent the investments in the general account of an insurance company are to be considered plan assets. This guidance is to address specifically ERISA's fiduciary responsibility provisions and the excise tax on prohibited transactions in light of the U.S. Supreme Court's decision in John Hancock Mutual Life Insurance Co. v. Harris Trust and Savings Bank, holding that general account investments are considered plan assets.
   
   Effective.January 1, 1975. The DOL is required to issue proposed regulations no later than June 30, 1997, and final regulations no later than December 31, 1997. The regulations will only apply to insurance company general account contracts issued before January 1, 1999. Contracts issued on or after this date are subject fully to ERISA's fiduciary and prohibited transaction rules.
   
   Suggested Action.Investments in insurance company general accounts pursuant to contracts issued after 1998 will effectively not be permitted. Insurance companies will need to develop alternative products.

7. Prohibited Transaction Excise Tax. The initial excise tax on prohibited transactions between a qualified plan and a disqualified person has been increased from 5% to 10%.
   
   Effective.Prohibited transactions occurring after August 20, 1996.

8. Keogh Plans. The special qualified plan aggregation rules that only apply to self-employed individuals is repealed.
   
   Effective. January 1, 1997.

IX. Church Plans

2. Self-Employed Ministers. A self-employed minister who makes contributions under a church plan will be treated as his own employer rather than an employee of the church. This change in the law is to encourage self-employed ministers to participate in church plans. Previously, a self-employed minister could not deduct the contributions made to the church plan, since the contributions were considered to have been made by the church.
   
   Other changes in the law which will affect ministers include the following:
   
   (1) For purposes of Section 403(b), a self-employed minister's includable compensation is based on his earned income, and his years of service include years as a self-employed minister.
   
   (2) A self-employed minister can make a contribution to a retirement income account under §403(b)(9), deductible up to the limits on elective deferrals under §402(g)(3) and annual additions under §415 and the §403(b)(2) exclusion allowance.
   
   (3) If a minister covered under a church plan is not employed by an organization which is tax-exempt under §501(c)(3), the minister is treated as employed by a tax-exempt employer.
   
   (4) If the minister's employer is not eligible to maintain a church plan, the minister is not considered an employee of the employer when the various nondiscrimination rules are applied to the employer's pension plans.
   
   (5) Compensation taken into account in determining contributions or benefits under a church plan cannot be taken into account in determining contributions or benefits to non-church plans.
   
   Effective.These changes are effective for years beginning after December 31, 1996.
   
   Suggested Action.These changes should be communicated to self-employed ministers. Plan language should be reviewed and amended if necessary.

3. Self-Employment Tax -- Ministers. A minister is no longer subject to self-employment tax on the rental value of any parsonage or parsonage allowance provided to him after retirement, whether or not the rental value is excluded from gross income under Code Section 107. Retirement benefits received by a minister from a church plan are not subject to self-employment tax.
   
   Effective.This change is effective retroactively for tax years beginning before, on, or after December 31, 1994.
   
   Suggested Action. Advise retired ministers to file refund claims for self-employment tax paid on parsonage and retirement benefits.

4. Foreign Missionaries. To determine the taxable portion of a distribution from an annuity contract, an employee's investment includes any employer contributions for foreign missionary services to the extent the contributions would have been excludable from income if paid directly to the missionary. This change will cover such employer contributions, even if the amount would have been excludable under the foreign income exclusion.
   
   Effective.Years beginning after December 31, 1996.

5. Highly Compensated Employees for Church Plans. When applying the nondiscriminatory classification test to church plans, an employee will only be considered an officer, supervisor or highly compensated employee if the employee is a highly compensated employee, as defined under §414(q)(1). The IRS may also create nondiscrimination and coverage test safe harbors for church plans.
   
   Effective. Plan years beginning after December 31, 1996.
   
   Suggested Action.Sponsors of church plans should review their procedures used to determine who is a highly compensated employee for coverage and nondiscrimination tests.