Financial Institutions Tax-Favored Savings Accounts Alert QUALIFIED RETIREMENT PLANS ■ INDIVIDUAL RETIREMENT ACCOUNTS ■ 403(b) PLANS ■ 457 PLANS 529 PLANS ■ COVERDELL EDUCATION SAVINGS ACCOUNTS ■ HEALTH SAVINGS ACCOUNTS SEPTEMBER 2005

Internal Revenue Service Changes Rules Regarding Timing of Determination and Opinion Letter Applications On August 26, 2005, the Internal Revenue Service (IRS) published Revenue Procedure 2005-66, which substantially changes the deadlines for submitting taxqualified retirement plans to the IRS for a review of their tax-qualified status. In order to ensure that their plans continue to comply with all relevant tax qualification rules, employers that sponsor individually designed plans now will need to submit determination letter applications regularly once every five years, and sponsors of master, prototype and volume submitter plans now will need to submit applications for opinion letters once every six years. (This Alert generally refers to master, prototype and volume submitter plans collectively as pre-approved plans.) BACKGROUND

The terms of all tax-qualified retirement plans are required to comply in form with the tax-qualification requirements of Section 401(a) of the Internal Revenue Code. Employers that sponsor individually designed plans can obtain assurance from the IRS that the terms of their plans comply with Section 401(a) by applying for and obtaining a favorable determination letter from the IRS. Employers that adopt pre-approved plans generally can obtain that assurance by relying on an opinion letter issued by the IRS to the organization 1

that sponsors the pre-approved plan. The sponsor of the pre-approved plan must periodically apply for and obtain an opinion letter, but the employer generally does not need to apply for its own determination letter. (However, in some limited circumstances, an employer that adopts a pre-approved plan may need to apply for a separate determination letter through a simplified determination letter application process.)1 As legislative and regulatory changes are made to the qualification rules (or, as employers and pre-approved plan sponsors adopt discretionary changes to their plans), employers and pre-approved plan sponsors must periodically obtain new determination and opinion letters that take the changes into account. If the IRS determines that the terms of the plan fail to adequately reflect the required changes (or that a discretionary amendment contains a provision that does not otherwise comply with Section 401(a)), the IRS will permit the plan to be amended retroactive to the effective date of the change (or amendment), provided that the plan has been submitted to the IRS for a determination or opinion letter by the deadline applicable to that change or amendment. Under Section 401(b) of the Internal Revenue Code, the deadline for submitting an application for a determination or opinion letter is, generally, the due

The determination and opinion letter program is optional and employers are not required to apply for or obtain a favorable determination letter or to adopt a pre-approved plan that is the subject of a favorable opinion letter. However, except in rare circumstances, the IRS cannot disqualify a plan on the basis that the terms of the plan do not comply with the requirements of Section 401(a) if those terms are covered by a favorable determination letter or an opinion letter upon which the employer is entitled to rely. Because of this valuable protection, virtually every sponsor of a tax-qualified retirement plan obtains a favorable determination letter or adopts a pre-approved plan that is the subject of a favorable opinion letter and ensures that those letters are updated in a timely manner.

date (including extensions) of the employer’s tax return in the later of the year following the year in which the change or amendment is adopted or effective. This deadline is referred to as the last day of the plan’s remedial amendment period. Failure by an employer or a pre-approved plan sponsor to submit an application for a determination or opinion letter before the end of the plan’s remedial amendment period results in the inability of the employer or preapproved plan sponsor to later retroactively amend the plan to correct any defects that the IRS may discover as part of a review of a determination letter or opinion letter application or on audit. The IRS has discretion under Section 401(b) to extend the remedial amendment period deadline. So that employers and pre-approved plan sponsors will not need to submit new applications for determination and opinion letters annually (to reflect annual legislative and regulatory changes or to cover other discretionary changes to the plan), the IRS has historically exercised this discretion by imposing a single deadline with respect to a number of legislative and regulatory changes that become effective over a period of several years. The most recent example of this was the so-called “GUST” remedial amendment period deadline. The “GUST” acronym refers to a number of legislative and regulatory changes that became effective between 1994 and 2000. The remedial amendment period deadline for all of the “GUST” changes was, generally, the last day of the first plan year beginning on or after January 1, 2001 for employers sponsoring individually designed plans. Sponsors of pre-approved plans were required to apply for “GUST” opinion letters by December 31, 2000, in which case the employer’s remedial amendment period deadline was extended to September 30, 2003. The practice of requiring all plan sponsors to submit their plans en masse every few years has resulted in significant fluctuations in the IRS’s determination and opinion letter workload. The new rules in the Revenue Procedure reflect an attempt by the IRS to even out its determination and opinion letter work flow. As a by-product of that effort, the timing of determination and opinion letter applications will

2 SEPTEMBER 2005

become more predictable for employers and preapproved plan sponsors. INDIVIDUALLY DESIGNED PLANS

Five-Year Cycles On February 1, 2006, the IRS will begin to accept applications for determination letters for individually designed plans that take into account the requirements of the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”). Employers that sponsor individually designed plans will be required to apply for a new determination letter by January 31 of every fifth year. Thus, each employer will have a five-year determination letter application cycle. Employers’ five-year cycles will be staggered so that roughly 20% of all employers will be required to submit new determination letter applications every year. The five-year cycle applicable to an employer is determined by reference to the last digit of the employer’s federal taxpayer identification number (TIN). Appendix A attached to this Alert lists the five five-year cycles and the employers assigned to those cycles. For example, an employer whose TIN ends in 1 or 6 will be in the first group required to file under the new rules and must apply for a new determination letter by January 31, 2007, January 31, 2012 and every fifth year thereafter. As described in the Appendix, special rules apply to multiemployer plans, multiple employer plans, controlled groups, affiliated service groups, governmental plans and plan-related and sponsorrelated transactions, such as mergers, acquisitions, spinoffs and changes in plan sponsorship. No employer will be required to submit an application for a determination letter prior to January 31 of the first year of the first five-year cycle applicable to the employer. Thus, the remedial amendment period applicable to EGTRRA, which was formerly the first day of the first plan year beginning on or after January 1, 2005, is extended to January 31, 2007 for Cycle A employers and as late as January 31, 2011 for Cycle E employers. Determination Letter Coverage In mid-November of each year, the IRS will publish an annual Cumulative List of Changes in Plan KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP

Qualification Requirements (Cumulative List). The list will specify the changes in plan qualification requirements that the IRS will consider in its review of plans submitted for determination letters on and after January 31 of the second calendar year following publication of the list. The timing of the publication of the list is designed to give employers whose remedial amendment period expires on the second January 31 following publication of the list a one-year period between the February 1 of the year following the publication of the list and the January 31 of the second year following publication of the list to submit determination letter applications. Thus, for example, the IRS will publish the 2005 Cumulative List in November 2005. Cycle A employers can then submit determination letter applications between February 1, 2006 and January 31, 2007 and the determination letters they receive will cover all of the changes included in the 2005 list. Similarly, Cycle B employers will submit determination letter applications between February 1, 2007 and January 31, 2008, and the determination letters they receive will cover all of the changes included in the 2006 list. The IRS will not consider in its review of any application any qualification change that becomes effective, any guidance published, or any statutes enacted after the issuance of the applicable Cumulative List. The IRS will consider in its review of any application any qualification requirements in effect and any guidance published before the issuance of the applicable Cumulative List, whether or not included in that Cumulative List. Off-Cycle Filing Employers are discouraged from filing “off-cycle.” First, off-cycle employers will be given secondary priority to “on-cycle” employers—i.e., their applications will be reviewed only after all of the applications of on-cycle employers have been reviewed and processed. Second, if an employer files during a premature February 1 to January 31 period, the employer still will be required to file during its

3 SEPTEMBER 2005

next regularly scheduled cycle to ensure that it has a letter covering all of the changes reflected in the Cumulative List that apply to its cycle. For example, the first regularly scheduled filing cycle for an employer assigned to Cycle C would be February 1, 2008 through January 31, 2009. If the employer applies for a determination letter on June 1, 2007, the letter will cover changes reflected in the 2006 Cumulative List, but it will not cover changes reflected in the November 2007 Cumulative List for which the employer would have a January 31, 2009 application deadline. Thus, to ensure complete, timely determination letter coverage, the employer would need to apply for another determination letter between February 1, 2008 and January 31, 2009. Expiration Dates Currently, determination letters do not expire. That is, once issued, they can thereafter always be relied upon with respect to plan qualification changes covered by the letter. Under the new program, however, every determination letter will contain an expiration date, which will be the last day of the first five-year cycle that ends more than twelve months after the date on which the letter is issued. For example, if a Cycle A employer receives a determination letter on June 1, 2007, the employer’s determination letter will expire on January 31, 2012. In certain circumstances, the IRS may, through published guidance, extend the expiration dates of determination letters for a particular cycle year or years. Plan Terminations Terminated plans fall out of the five-year remedial amendment period cycle because the termination of a plan ends the plan’s remedial amendment period. An application for a determination letter for a terminated plan will be considered timely only if it is filed no later than the later of (i) one year from the effective date of the termination, or (ii) one year from the date on which the termination is authorized, but no later than 12 months after the date of distribution of substantially all of the plan’s assets.

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PRE-APPROVED PLANS

Six-Year Cycles Sponsors of pre-approved plans will be required to apply for new opinion letters once every six years. Pre-approved defined contribution plans will be on a different six-year cycle than pre-approved defined benefit plans. As described in Appendix A, each sponsor of a pre-approved defined contribution plan generally must apply for a new opinion letter during the 12-month period beginning February 1, 2005 and ending January 31, 2006, and every sixth year thereafter, and each sponsor of a pre-approved defined benefit plan must generally apply for a new opinion letter during the 12-month period beginning February 1, 2007 and ending January 31, 2008, and every sixth year thereafter. (As indicated in Appendix A, the filing windows for “mass submitter” and “national” preapproved plan sponsors generally close earlier than the windows for other pre-approved plan sponsors (October 31 of the first year of each six-year cycle rather than January 31). However, the IRS extended the October 31, 2005 submission deadline to January 31, 2006 for defined contribution mass-submitter plans.) Opinion Letter Coverage The opinion letters received by pre-approved plan sponsors will cover all of the changes included in the Cumulative List that is published in November of the year immediately prior to the February 1 that begins the filing period described above. Thus, a preapproved defined contribution plan sponsor that files for an opinion letter during the 12-month filing period beginning on February 1, 2005 will receive an opinion letter covering all of the changes included in the November 2004 Cumulative List. This includes changes required by EGTRRA. Review Period The IRS review period for pre-approved plans will last approximately two years from the end of the 12-month filing period described above. Near the end of this two-year review period, the IRS will publish an announcement notifying adopting employers of the date by which they must adopt the pre-approved plans. The announced deadline will mark the end of

4 SEPTEMBER 2005

the plan’s remedial amendment cycle. The deadline date will give virtually all adopting employers a twoyear adoption period within which to adopt the updated pre-approved plan. If the employer adopts the pre-approved plan by the announced deadline date, the employer will have adopted the plan within the employer’s six-year remedial amendment period. For example, it is expected that the IRS will issue opinion letters by January 31, 2008 to pre-approved defined contribution plan sponsors that submit their applications for opinion letters by January 31, 2006 (two years from the end of the application period). Employers would have until approximately January 31, 2010 to adopt the plan. Eligibility for Six-Year Pre-Approved Plan Cycle An adopting employer will be treated as having adopted a pre-approved plan if, prior to the end of the five-year cycle that would otherwise apply to the employer if it maintained an individually designed plan, the employer either (i) adopts a sponsor’s approved (or interim) pre-approved plan or (ii) together with a pre-approved sponsor, executes IRS Form 8905, Certification of Intent to Adopt Preapproved Plan, and then, prior to the end of the twoyear adoption period announced by the IRS, the employer adopts any pre-approved or individually designed plan. (Form 8905 is not expected to be available for several months, but when available it will be posted at www.irs.gov/ep.) If the adopting employer complies with either of these rules, and if the pre-approved plan sponsor has timely submitted its pre-approved plan for an opinion letter, the adopting employer’s plan will be eligible for the six-year remedial amendment cycle. These rules apply regardless of whether the employer is adopting a new plan or restating an existing individually designed plan in the form of a preapproved plan. Effect of Converting a Pre-Approved Plan to an Individually Designed Plan If a pre-approved plan is modified so that it becomes an individually designed plan, the plan may be

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required to switch from the six-year pre-approved plan cycle to the five-year individually designed plan cycle. Whether a switch is required (and the timing of that switch, if any,) depends upon the nature of the modification: ■

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If the plan continues to be based upon a preapproved plan but has become individually designed merely because the employer has impermissibly modified the pre-approved plan document in good faith with the intent of maintaining the qualified status of the plan, and the IRS determines that the modifications are not so substantial that the plan should be subjected to the five-year remedial amendment period cycle, the employer will continue to be eligible to use the six-year remedial amendment pre-approved plan cycle. An employer in this situation would need to submit a determination letter application on either Form 5300 or Form 5307 (depending upon whether the employer modified a pre-approved plan document or modified a word-for-word volume submitter document). If the plan continues to be based upon a preapproved plan but has become individually designed because the employer has impermissibly modified the pre-approved plan document, and the IRS determines that the modifications are so substantial that the plan should be subjected to the five-year remedial amendment individually designed plan cycle, the employer will be immediately subject to the five-year individually designed plan cycle. If the pre-approved plan is completely restated and replaced by a custom designed document that is not based upon the pre-approved plan, then the employer will be entitled to rely on the six-year cycle in which the plan is restated, but must then switch to the appropriate five-year individually designed plan cycle. The employer would need to submit a determination letter application before the end of the current six-year cycle and again by the end of the first five-year cycle that ends after the current six-year cycle. If the first five-year cycle ends less than 12 months after the current six-year

5 SEPTEMBER 2005

cycle, the plan’s current cycle is extended for 12 months and the next five-year cycle is shortened accordingly. TIMING OF PLAN AMENDMENTS

Notably, the new rules contained in Revenue Procedure 2005-66 only change the deadlines for submitting determination letter applications (thereby permitting retroactive changes to previously adopted amendments). They do not directly change the dates by which plans must be initially amended to reflect changes in applicable law. Although the IRS may extend amendment deadlines from time to time, the general deadline for amending plans to comply with changes in applicable law remains the due date of the plan sponsor’s income tax return (including extensions) for the year in which the change becomes effective or becomes operative). Thus, although the new rules will permit plan sponsors to avoid frequent opinion and determination letter application filings, they will not necessarily permit plan sponsors to avoid periodic plan amendments to reflect changes in the law from time to time between such applications. A good example of this is EGTRRA. Although Revenue Procedure 2005-66 extends the deadline for submitting an opinion or determination letter application covering changes required by EGTRRA, the Revenue Procedure did not extend the deadline by which plans were required to be amended (in “good faith”) to reflect EGTRRA changes. That deadline was, generally, the last day of the plan year in which the EGTRRA change became effective or, if later, was implemented. Since many EGTRRA changes were mandatory and became effective January 1, 2002, this means that calendar year plans were generally required to adopt “good faith” EGTRRA amendments by December 31, 2002. Plans for which determination applications are timely submitted under the new determination letter program will then be entitled to retroactively change those EGTRRA amendments to correct any defects identified by the IRS as part of the review of the application.

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IMPACT OF NEW RULES

The primary purpose of the new rules is to even out the IRS’s work flow. Employers, plan sponsors and qualified retirement plan record keepers may also benefit from the new rules to the extent that a smoother work flow results in faster processing of determination letter applications (which can often take up to 12 months). However, those benefits will come at the cost of creating a need to more closely track determination letter application deadlines. The new rules place a premium on calendaring such deadlines. In addition, record keepers will need to communicate with their clients frequently to stay abreast of developments

(such as changes in plan and controlled group status) that may change their clients’ deadlines. Sponsors of defined contribution pre-approved plans will need to act quickly, as the January 31, 2006 deadline for submitting opinion letter applications for such plans is less than six months away.

Michael A. Hart 412.355.6211 [email protected] Lynn H. DuBois 415.249.1037 [email protected]

Our Financial Institution Tax-Favored Savings Accounts practice is part of our Employee Benefit Plans/ERISA practice. If you have any questions or would like more information about K&LNG’s Employee Benefit Plans/ERISA practice group, please contact one of the Compensation and Benefit lawyers listed below. Boston

Peter J. Marathas, Jr. Stephen E. Moore

617.951.9072 617.951.9191

[email protected] [email protected]

Los Angeles

William P. Wade

310.552.5071

[email protected]

New York

David E. Morse

212.536.3998

[email protected]

Pittsburgh

William T. Cullen Michael A. Hart J. Richard Lauver Charles R. Smith Richard E. Wood Sonia A. Chung Douglas J. Ellis

412.355.8600 412.355.6211 412.355.6454 412.355.6536 412.355.8676 412.355.6716 412.355.8375

[email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

San Francisco

Laurence A. Goldberg Marc R. Baluda Lynn H. DuBois

415.249.1043 415.249.1036 415.249.1037

[email protected] [email protected] [email protected]

Washington

Catherine S. Bardsley David E. Pickle William A. Schmidt Lori G. Galletto Brendan S. McParland

202.778.9289 202.778.9887 202.778.9373 202.778.9024 202.778.9210

[email protected] [email protected] [email protected] [email protected] [email protected]

www w.. k l n g . c o m BOSTON DALLAS HARRISBURG LONDON LOS ANGELES MIAMI NEWARK NEW YORK PALO ALTO PITTSBURGH SAN FRANCISCO WASHINGTON ■

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Kirkpatrick & Lockhart Nicholson Graham LLP (K&LNG) has approximately 1,000 lawyers and represents entrepreneurs, growth and middle market companies, capital markets participants, and leading FORTUNE 100 and FTSE 100 global corporations nationally and internationally. K&LNG is a combination of two limited liability partnerships, each named Kirkpatrick & Lockhart Nicholson Graham LLP, one qualified in Delaware, U.S.A. and practicing from offices in Boston, Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Palo Alto, Pittsburgh, San Francisco and Washington and one incorporated in England practicing from the London office. This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Data Protection Act 1988 - We may contact you from time to time with information on Kirkpatrick & Lockhart Nicholson Graham LLP seminars and with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please e-mail [email protected] if you would prefer not to receive this information.

© 2005 KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP. ALL RIGHTS RESERVED.

APPENDIX A Five-Year Remedial Amendment Cycles for Individually Designed Plans If the last digit of the plan sponsor’s TIN is — 1 or 6 2 or 7 3 or 8 4 or 9 5 or 0

The plan’s cycle is —

The last day of the EGTRRA remedial amendment period (i.e., the first cycle) is —

Cycle A Cycle B Cycle C Cycle D Cycle E

January 31, 2007 January 31, 2008 January 31, 2009 January 31, 2010 January 31, 2011

The next five-year remedial amendment cycle ends on — January 31, 2012 January 31, 2013 January 31, 2014 January 31, 2015 January 31, 2016

Six-Year Remedial Amendment Cycles for Defined Contribution Pre-approved Plans Initial EGTRRA application due —

Next application due —

Sponsors of Master and Prototype Plans: February 17, 2005 through January 31, 2006

February 1, 2011 through January 31, 2012

Mass Submitters and National Sponsors: February 17, 2005 through January 31, 2006 (one time extension of the otherwise applicable October 31 deadline)

February 1, 2011 through October 31, 2011

Six-Year Remedial Amendment Cycles for Defined Benefit Pre-approved Plans Initial EGTRRA application due —

Next application due —

Sponsors of Master and Prototype Plans: February 1, 2007 through January 31, 2008

February 1, 2013 through January 31, 2014

Mass Submitters and National Sponsors: February 1, 2007 through October 31, 2007

February 1, 2013 through October 31, 2013

A-1 SEPTEMBER 2005

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Multi employer and Multiple Employer Plans; Governmental Plans A plan that is a multi employer plan will be subject to the five-year remedial amendment Cycle D. A multiple employer plan will be subject to the five-year remedial amendment Cycle B. A governmental plan, including a governmental plan that is a multiple employer plan, will be subject to the five-year remedial amendment Cycle C. Controlled Groups and Affiliated Service Groups A plan maintained by multiple members of a controlled group under Code Section 414(b) or (c) or an affiliated service group under Code Section 414(m) will be subject to the five-year remedial amendment period applicable to the TIN used to report the plan on Form 5500, Annual Return/Report of Employee Benefit Plan.

Corporate Transactions If there is a change in the employer that maintains a plan (due to a merger, acquisition, spinoff or change in plan sponsorship), the plan’s remedial amendment cycle following the change will be determined based on the TIN of the employer that maintains the plan following the change. If this change in the amendment cycle would create a remedial amendment cycle shorter than twelve months, the current cycle will be extended for twelve months and the next fiveyear cycle is shortened accordingly. This extension does not apply to any other plans of the employer that are not similarly affected.

Instead of the rule above, if more than one plan is maintained by the members of the controlled group or affiliated service group, the members may elect to have all plans (other than multi employer or multiple employer plans) of all members of the group be subject to the five-year Cycle A remedial amendment period. The election must be made jointly by all members of the group and must list all members of the group, each member’s TIN, and all plans (other than multi employer or multiple employer plans) that are maintained by each member of the group. If more than one plan is maintained by a parent-subsidiary group, the parent may elect to have all plans subject to the remedial amendment cycle determined by reference to the parent’s TIN. The election must be filed with the first determination letter application submitted in accordance with Revenue Procedure 2005-66 for any plan maintained by any member of the group. For example, if one member uses Cycle B and one member uses Cycle C, the election must be made by the due date for Cycle B applications. Once made, the election may not be modified or revoked unless there is a change in the controlled group or affiliated group status.

A-2 SEPTEMBER 2005

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