Daily Tax Update - August 3, 2007


TREASURY, IRS ISSUE NEW PROPOSED CAFETERIA PLAN REGULATIONS:  Today, the Treasury Department and the IRS issued new proposed regulations for employee benefit plans under Section 125 of the Internal Revenue Code.  The plans, called “cafeteria plans,” allow employees to choose between receiving taxable cash compensation or tax-free employee benefits, such as health care, dependent care, and other fringe benefits.

  • The new proposed regulations generally preserve the rules of the existing proposed regulations, while adding clarifications relating to statutory changes and administrative guidance changes since the previous regulations were published.  The new regulations also address many issues on which the IRS has previously provided informal guidance.
  • The new proposed regulations:
    • Reiterate the IRS position that cafeteria plans are generally the sole method of preserving the nontaxable nature of employer-provided benefits where employees are allowed to elect between taxable compensation and nontaxable benefits, and emphasize the need for a written plan document.
    • Include new rules for determining if a cafeteria plan improperly discriminates in favor of highly compensated employees, including definitions of key terms.  The new rules are generally consistent with the rules for qualified retirement plans.  Also, the rules provide an objective test to determine if the actual election of benefits is discriminatory.  Very generally, this objective test requires that the aggregate contributions used to provide nontaxable benefits used by highly compensated participants, as a percentage of their aggregate compensation,  not exceed the aggregate contributions used by nonhighly compensated participants, measured as a percentage of their aggregate compensation.  A safe harbor for medical benefits is also provided.
    • Incorporate guidance previously issued relating to debit cards and grace periods for using health Flexible Spending Arrangements (health FSAs) money after the end of a plan year.
    • Generally retain the rules in the prior regulations for health flexible spending arrangements (health FSAs), including a 12-month plan year, requirements that the full reimbursement be available at anytime during the plan year, restrictions on changing elections in mid-plan year, and the requirement that unused amounts at plan year end (or, if permitted by the plan, at the end of the allowable "grace period") are forfeited (the “use-or-lose” rule).
  • The IRS requests comments on the proposed regulations and will hold hearings on the proposed regulations on November 15, 2007.  Taxpayers may rely on the proposed regulations for guidance pending the issuance of final regulations.
  • For additional information, contact - Anne E. Moran - amoran@steptoe.com
  • The regulations can be accessed via: http://www.steptoe.com/attachment.html/3113.pdf 

STEPTOE’S UK AUGUST 2007 TAX LAW UPDATE CAN BE ACCESSED VIA: http://www.steptoe.com/assets/attachments/3109.pdf 

S. 1963: A bill to amend the Internal Revenue Code of 1986 to allow bonds guaranteed by the Federal home loan banks to be treated as tax exempt bonds.
Sponsor: Sen. Rockefeller, John D., IV [WV] (introduced 8/2/2007)      Cosponsors (3)

S. 1973: A bill to amend the Internal Revenue Code of 1986 to double the period of limitations for returns involving offshore secrecy jurisdictions, to modify certain other provisions relating to the statute of limitations, and for other purposes.
Sponsor: Sen. Salazar, Ken [CO] (introduced 8/2/2007)      Cosponsors (None)

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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