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Pension Protection Act of 2006

The recently passed Pension Protection Act of 2006 is a massive tax bill that overhauls the funding and disclosure rules for defined benefit plans, addresses conversions of pension plans to cash balance plans, carries liberalized payout and rollover rules, and makes a host of other changes relating to pension plans and their beneficiaries.

We have included information in the following areas:

• Reform of the Single-Employer Defined Benefit Rules
• Reform of the Multi-Employer Pension System
• New Disclosure Rules for Qualified Plans
• New Investment Advice Rules
• Liberalized Plan Payout and Rollover Rules
• Retirement Savings Provisions Made Permanent
• Charitable Reforms

Below is an overview of the key tax changes that result from this important new legislation: 

Reform of the Single-Employer Defined Benefit Rules

• Employers must make contributions to their single-employer defined benefit pension plans over the next seven years in order to make them 100% funded.
• The discount rate used to calculate the present value of current pension liabilities is based on a segmented yield curve of corporate bonds.
• Accelerated contributions for “at-risk” plans.
• Reduces the smoothing of interest rates to two years.
• Permits employers to make additional maximum deductible contributions.
• Prohibits further benefit accruals for lump-sum distributions or shutdown benefits from plans funded at less than 60%.
• Restricts use of deferred executive compensation arrangements for employers with severely under-funded plans.
• Permanently establishes an employer-paid termination premium of $1,250 per participant if a plan sponsor terminates its employee pension plan upon entering bankruptcy.
• Establishes special rules for airlines.

Reform of the Multi-Employer Pension System

• Identifies under-funded multi-employer pension plans and establishes quantifiable benchmarks for measuring a plan's funding improvement.
• Provides new notice requirements for under-funded plans.
• Changes the amortization schedule for any plan benefit amendments from 30 years to 15 years.
• Increases the maximum deductible limit to 140% of current liability.
• Requires plan trustees to improve the health of the plan by one-third within 10 years if a plan is less than 80% funded or will hit a funding deficiency within seven years.
• Prohibits benefit increases if the increase causes the plan to fall below 65% funded status.

New Disclosure Rules for Qualified Plans

• Requires both single and multi-employer plans to include more detailed and specific information on their Form 5500 filings.
• Makes all Form 4010 information filed with PBCG available to the public with the exception of corporate proprietary information, and enhances Form 4010 disclosure requirements.
• Establishes an 80%, at-risk threshold to determine whether plans pose a threat to PBGC and therefore must file 4010 information.
• Requires both single and multi-employer pension plans to notify workers and retirees of the funded status of their plan within 120 days after the close of the plan year.
• Prohibits companies from forcing employees to invest any of their own retirement savings contributions in the stock of the employer.
• Clearly states companies have a fiduciary responsibility for workers' savings during “blackout” periods, when workers are temporarily barred from making changes to their 410(k) investments.
• Requires companies to give workers quarterly benefit statements including information on the value of their assets, their rights to diversify, and the importance of maintaining a diversified portfolio.

New Investment Advice Rules

• Permits qualified “fiduciary advisers” to offer investment advice to help employees manage their 401(k) and other retirement options.
• Establishes fiduciary and disclosure safeguards to ensure advice provided to employees is solely in their best interest.
• Requires fiduciary advisers for employer-sponsored plans to base their recommendations on a computer model that is certified and audited by an independent party.
• Requires fiduciary advisers for non-employer sponsored plans to charge a flat rate fee for one year (with no computer model).

Liberalized Plan Payout and Rollover Rules

• Permits taxpayers to make direct rollovers from qualified plans to Roth IRAs after 2007. 
• Pertaining to the 401(k) hardship distribution rules, “hardship” applies to hardship of any beneficiary under the plan.
• Allows members of the National Guard and Reserves called to active duty through 2007 to make penalty-free withdrawals from retirement plans. Withdrawn amounts may be repaid to the IRA or pension plan within two years of the distribution.
• Waives the 10% early withdrawal penalty for distributions to public safety employees over age 50 (including police, fire, and emergency medical services) who may retire early. 
• Effective for post-2006 distributions non-spouse designated beneficiaries are allowed to make rollovers of inherited amounts in qualified plans, governmental Sec. 457 plans, or tax-sheltered annuities to their own IRAs (treated as inherited IRAs).
• Effective for distributions in plan years beginning after 2006, defined benefit plans can make in-service distributions to age-62-or-older participants.

Retirement Savings Provisions Made Permanent

The Act makes permanent a number of retirement plan and IRA liberalizations that were added to the tax laws in 2001 but were set to sunset after 2010. By making the 2001 changes permanent, the new law preserves the advantages of higher employee contribution limits for employer plans, higher IRA contribution limits, more flexible plan rules, portability, a catch-up for those over 50, and an increase in employer contribution limits. The new law also makes permanent the saver's credit, which would not have been available after 2006 without the extension.

Charitable Reforms

• The incentives below are each effective for two years through 2007:
• Tax-free distributions from IRAs for charitable purposes. Taxpayers can exclude from gross income certain distributions of up to $100,000 from a traditional or Roth IRA if made to a qualified tax-exempt organization.
• Charitable deduction for contributions of food inventory. An enhanced deduction for donations of food inventory which was formerly available only to C corporations is extended to all trades and businesses.
• Basis adjustment to stock of S corporation contributing property. If an S corporation contributes property to a charity, an S corporation shareholder only has to reduce his basis in stock of the S corporation by his pro rata share of the adjusted basis of the contributed property, rather than by the amount of the charitable contribution that flows through to him.
• Charitable deduction for contributions of book inventory. The current-law provision adds public schools to the list of eligible donees for the enhanced deduction for contributions of qualified book inventory by C corporations.
• Qualified conservation contributions. The new law raises the charitable deduction limit—from 30% of adjusted gross income to 50%—for qualified conservation contributions, as long as it does not prevent the use of the donated land for farming or ranching purposes. The charitable deduction limit is raised to 100% of adjusted gross income for eligible farmers and ranchers. Unused contributions can be carried forward for up to 15 years.

On the charitable reform side, the new rules:

• Require reports to the Treasury Department on certain life insurance contracts.
• Double the fines and penalties applicable to certain activities by charities, social welfare organizations, private foundations and exempt organization managers.
• Clarify the terms of facade easements in historic districts, and also clarify that the charitable deduction is reduced if a rehabilitation tax credit has been claimed with respect to the donated property.
• Limit the basis for donated taxidermy property and provide that the value of the deduction is equal to the lesser of basis or fair market value.
• Require the recapture of any tax benefit derived from the contribution of property with respect to which a fair market value deduction was claimed if the property is not used for an exempt purpose of the donee organization, effective for contributions made after Sept. 1, 2006.
• Generally prohibit deductions for contributions of clothing and household items unless they are in good used condition or better.
• Require for a charitable contribution of money, regardless of the amount, the donor must maintain a cancelled check, bank record or receipt from the donee organization showing the name of the donee organization, the date of the contribution, and the amount of the contribution, effective for contributions made after the enactment date.
• Lower the threshold for imposing accuracy-related penalties on a taxpayer who claims a deduction for donated property for which a qualified appraisal is required.
• Impose certain requirements on tax-exempt organizations that offer credit counseling services.
• Apply an excess benefits transaction tax on any grant, loan, compensation or other similar payments from a donor-advised fund to a person that with respect to such fund is a donor, donor adviser, or a related person, and from a supporting organization to a substantial contributor or a related person.
• Require unrelated business income tax returns of 501(c)(3) organizations be made publicly available.