Academic journal article Journal of Accountancy

IRS States Position on Hybrid Plan Arrangements

Academic journal article Journal of Accountancy

IRS States Position on Hybrid Plan Arrangements

Article excerpt

The IRS released a coordinated issue paper for all industries on the use of pension plan distributions to pay for certain benefits. The paper says the portion of pension plan distributions former employees use to purchase benefits in their employer's cafeteria plan under a tax-free salary reduction does not reduce the amount of the taxable distribution. An employer cannot utilize this cafeteria plan/qualified retirement plan hybrid arrangement to lower health care expenses or taxable pension distributions for its former employees.

FASB Statement no. 106, Employers Accounting for Postretirement Benefits Other Than Pensions, created an incentive for employers to use alternative methods to provide accident and health benefits to retirees. The purpose was to offset the effect of retiree health obligations on employers' financial statements and reduce the escalating costs of accident and health coverage to employers.

One proposed FASB method permitted retirees to apply a salary reduction agreement to their pension distributions. The employers would then use the distributions to purchase accident and health coverage for the former employees through their cafeteria plan. The employers would then report the retirement distributions on forms 1099R, less the benefit costs, effectively paying the health benefits with pretax dollars.

The IRS rejected FASB's proposed method. It said IRC section 125, which governs cafeteria plans, allows employees to defer, tax-free, part of their salaries to purchase certain benefits. But section 125 only allows salary or income as defined under section 61 to be deferred. The FASB method would defer pension income, which is not considered income under section 61. …

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