IRS Indicates Guidance Coming on 457 Plans

According to CCH, Cheryl Press, a senior attorney with the IRS Associate Chief Counsel (Tax Exempt and Government Entities), noted that the IRS has not issued major guidance under Code Section 457 since it released final regulations in 2003.

She expects guidance on ineligible plans under Code Section 457(f); the definition of a governmental plan under Code Section 414(d); excess benefit plans under Code Section 415(d); and welfare benefit plans excluded from Code Section 457, such as bona fide sick and vacation leave, severance, and death benefit plans.

Press said that in the meantime, the IRS is issuing private letter rulings and responses to congressional inquiries on hardship issues, grandfathered plans, and other concerns. Press and Bill Bortz, Treasury associate benefits tax counsel, spoke at an American Law Institute-American Bar Association (ALI-ABA) conference on deferred compensation plans of tax-exempt and governmental employers.

Prior Guidance

Bortz noted that the 2003 regulations focused on eligible Code Section 457(b) plans and provided less guidance on the exceptions to Code Section 457 and ineligible 457(f) plans. CCH said he further noted that various legislative changes that have yet to be addressed under Code Section 457, include the enactment of Code Section 409A deferred compensation requirements; new rules expanding eligible rollovers to nonspouse beneficiaries; and rollovers of payments under Code Section 402(l) for retiree medical benefits.

Notice 2007-62 requested comments on a number of Code Section 457 issues that need guidance (see Guidance Coming, Comments Requested on § 457: IRS ). Bortz said comments focused particularly on severance pay plans and whether the definition should incorporate elements of the 409A definition (benefits limited to twice final compensation; benefits conditioned on involuntary termination).

Covenants not to compete

According to CCH, Bortz expressed concern about 457 plans deferring benefits using covenants not to compete and rolling risks of forfeiture. While the issues involve specific facts and circumstances, Bortz said he does not think these clauses work. Press said she has never seen a good noncompete clause. A big problem is that employers do not monitor the actions of their former employees, so there is no enforcement, she stated.

Corrections and audits

Press said, the government also is exploring relief for 457 plans maintained by agencies and instrumentalities that believed they were government employers (which must maintain funded plans) but turned out to be private exempt organizations. Correction of 457 plans is less of an issue for actual government employers, who have 180 days to correct their plans retroactively after notice from the IRS, she stated, according to CCH.

She also expressed some concern about the treatment of amounts deferred until retirement as severance pay, ineligible plans under Code Section 457(f), and employees entitled to "buckets of benefits" with a default allocation to a 457(f) plan. While the IRS is less concerned about government plans, it will audit them if there is an interaction between Code Sections 403(b) and 457.

Hardship distributions

The IRS is receiving a number of inquiries, such as letters from Congress, concerning 457 plan participants who have been denied a hardship distribution, Press stated. She said that plan administrators are very conservative since hardship distributions are an optional plan provision. The IRS changed the rules to allow distributions for circumstances affecting dependents, and the IRS intended for this to add flexibility, but administrators saw it as a tightening of the rules. So the IRS has instructed plan administrators to "loosen up a little bit," she said.

The IRS "wants to see good practices and procedures," a trail of information documenting the reason for the hardship distribution, Press told the conference, emphasizing that the IRS looks for certification and back-up information, according to the news report.