By Robert J. Friedman, Esq., Austin K. Stack, Esq.
On May 9, 2014, the U.S. Department of the Treasury and
Internal Revenue Service released final regulations regarding
amounts from a qualified plan that are used to pay for accident or
health insurance premiums (T.D. 9665, RIN 1545-BG12, 79 Fed. Reg.
26838 (5/12/14). The final regulations generally adopt the
provisions of the proposed regulations published in August 2007,
with one notable exception created for insurance that makes
contributions on behalf of a participant while he or she is unable
to work due to disability.
Under the proposed
regulations and the final regulations,
amounts from a qualified plan used to pay for accident or health
insurance premiums generally are taxable distributions under
§402(a) unless a statutory exception applies. If the premiums are
paid from a contribution or forfeiture that has not yet been
allocated to a participant's account, the payment will first count
as being paid to the participant and then contributed by the
participant to the plan. In addition, the payment made by the plan
will count as a taxable distribution to the participant under
Premiums Not Taxable Under Specific
However, the general rule does not apply to special "plan
contribution replacement" disability insurance policies that pay
benefits to a participant's account during the period of the
participant's disability. Normally, if the participant stops
working due to a disability, the participant is unable to continue
making salary deferrals and receiving employer contributions under
the plan. Under the special disability policy, if a participant is
not working during a disability period, the policy will make
payments to the plan for the benefit of the participant. The final
regulations make an exception for payments by a plan for the
premiums for such special disability policies. If certain
conditions are met, the premium payments by the plan are not
treated as taxable distributions and the benefits paid to the
participant's account in the plan are treated as investment
earnings rather than contributions.
The exception for the
special disability policies applies only
if all of the following conditions are met:
the premium payments must be paid directly from the plan;
Benefit Payments Allowed to Increase
The payments of benefits under the policy are allowed
increase to reflect reasonably expected future salary
increases. However, if the special disability insurance
premium is not paid by the plan or out of contributions to the
plan, then amounts received by the plan under the disability
insurance contract will be treated as contributions to the plan and
be subject to the general rules that apply to qualified plan
contributions. Further, if the employer does not finance the
disability coverage through third-party insurance, then the amounts
paid to the plan will also be considered contributions to the plan.
Although it appears that the special disability policy would have
to be owned by the plan, it appears that the participant could
negotiate the terms of the policy. The plan document likely would
need to be amended to permit the plan to hold the special
disability policy, make the premium payments and allocate any
benefits paid to the account of the insured participant.
The final regulations apply for taxable years beginning on or
after January 1, 2015, though taxpayers may elect to apply the
regulations to earlier taxable years.
Employers should consider the following steps:
To ensure compliance with
Treasury Regulations (31 CFR Part 10,
§10.35), we inform you that any tax advice contained in this
correspondence was not intended or written by us to be used, and
cannot be used by you or anyone else, for the purpose of avoiding
penalties imposed by the Internal Revenue Code.
contained in this alert is for the general education
and knowledge of our readers. It is not designed to be, and should
not be used as, the sole source of information when analyzing and
resolving a legal problem. Moreover, the laws of each jurisdiction
are different and are constantly changing. If you have specific
questions regarding a particular fact situation, we urge you to
consult competent legal counsel.
more information, in the Tax Management Portfolios, see
Bosley and Hutzelman, 370 T.M., Qualified Plans - Taxation of
Distributions, Cowart, 389 T.M., Medical Plans - COBRA,
HIPAA, HRAs, HSAs and Disability, and in Tax Practice Series,
see ¶5550: Tax Aspects of Qualified Retirement Plans, ¶5920, Health
& Disability Plans.
Copyright © 2014 Holland & Knight LLP. All Rights
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