Confused taxpayers write to senators, representatives, and the white house with questions about tax law, asking whether current or former employers followed tax law properly, or why certain rules seem to promote unfair treatment. The IRS National Office is the final stop for these enquiries, and sometimes the IRS writes back, offering general information about the income tax code.
Here’s a sampling of recent information letters so you can test yourself to learn how much you know about “well-defined” tax code provisions.
You can roll over after-tax dollars in a 401k plan distribution to one retirement account, and the pre-tax dollars to another. Yet those rules do not apply to an IRA. Besides the obvious “because the law says so,” do you know why?
Source: Information letter 2016-0049
A health care sharing ministry is a tax-exempt organization whose members share a common set of beliefs, as well as medical expenses in accordance with those beliefs. Members of these ministries are not required to have minimum essential coverage under the Affordable Care Act, and membership is not minimum essential coverage. In addition, tax law does not consider membership in a ministry as health insurance and payments for participating are not deductible medical care.
When employees decline coverage in an employer’s group health plan and instead participate in a health care sharing ministry, and the employer pays the costs of employee participation in the ministry, can the employer treat those costs as a nontaxable employee benefit?
Source: Information letter 2016-0051
The employer shared responsibility regulations under the Affordable Care Act have various rules about how to identify full-time employees, including the “13/26” rule that tells employers how to treat employees rehired after termination of employment or resuming service after other absence.
Under the employer shared responsibility regulations, the 13/26 rule treats an employee as a continuing employee of an educational institution unless the employee has a period of 26 weeks without an hour of service. In this case, the rule treats the employee as terminated from employment and rehired. (The rule is 13 weeks without an hour of service for employers that are not educational institutions.)
Based on the above wording, does the 13/26 rule require employees of an educational institution to take a six month (26 week) break in service following retirement before the employee can work part-time for the former employer?
Source: Information letter 2016-0052
Generally, under the Federal Insurance Contributions Act (FICA), an employer and employee each pay a social security tax of 6.2% and a Medicare tax of 1.45% of the employee wages for a total of 15.3%.
When the US Congress extended social security and Medicare coverage to the self-employed under the Self-Employment Contributions Act (SECA), a different tax structure was required since no employer-employee wage paying structure existed.
In general, under SECA the self-employed person pays the same 15.3% rate as employers and employees pay under FICA, though under SECA the tax rate is based on net self-employment income rather than wages.
Does tax law account for the fact that employees do not pay FICA or income tax on the value of an employer’s portion of social security and Medicare tax?
Source: Information letter 2016-0069
When you inherit a Roth IRA from someone other than your spouse, you generally have to take required minimum distributions from the account. Under the rules, you have a choice of how you will take distributions. You can use the “five-year rule,” which means you have to distribute the account in full within five years of the employee’s death. Alternatively, you can distribute the account over your life expectancy, beginning within a year after the employee’s death (the life expectancy rule).
Under treasury regulation 1.401(a)(9)-3, if you are a designated beneficiary, distributions are to be made over your life expectancy, unless the terms of the plan say you must or can use the five-year rule.
If the plan permits the five-year rule, you have to make the election to use the rule within a specific time period. Otherwise, distributions have to be made over your life expectancy, unless the plan says distributions will be made under the five-year rule if no election is made.
What happens if you fail to begin required distributions within one year of the Roth IRA owner’s death? Does the failure make the life expectancy rule inapplicable and require that you take distributions under the five-year rule instead?
Source: Information letter 2016-0071
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The rules in Notice 2014-54 treat funds that individuals roll over from a 401(k) plan to different retirement accounts at the same time as one distribution. Also, if an individual rolls over all the pre-tax dollars in one distribution, then, because of the rule in the last sentence of section 402(c)(2) (the “pre-tax-first rule”), that individual can roll over any after-tax dollars separately.
For example, an individual can directly roll over to a traditional IRA all the pre-tax dollars in a distribution and to a Roth IRA all the after-tax dollars. Different rules apply to distributions from designated Roth accounts in 401(k) plans.
The rules for distributions from traditional IRAs are in section 408(d) of the code. Under section 408(d), no pre-tax-first rule exists for traditional IRA distributions rolled over to IRAs, so the rules in Notice 2014-54 could not be extended to distributions from traditional IRAs.
If an individual’s traditional IRAs, when combined, contain both after-tax and pre-tax dollars, the rules treat any distribution as consisting of a proportionate share of each. Individuals can roll over (“convert”) any such distribution (except for any part that is a required minimum distribution because the IRA owner is 70½ or older) to a Roth IRA, but the pre-tax dollars in the conversion must be included in gross income.
Because participation in a health care sharing ministry is not employer-provided coverage under an accident or health plan, the law does not exclude employer payment for the cost of employee participation from the employee’s gross income. Instead, the law considers it as taxable income and wages to the employee.
We see no reason why the rules in the employer shared responsibility regulations would require you to have a six-month break in service after retirement before working as a part-time employee at the Northern Virginia Community College.
If your employer has told you that a break in service is required after retirement, the reason may be due to the terms of your retirement plan instead of any ACA requirement. Some retirement plans restrict distributions to employees who transfer to a part-time position with the same employer before incurring some minimum break in service.
Congress recognized that some differences between the taxes under SECA and FICA existed. To achieve parity between self-employed persons and employers and employees, congress enacted deductions under sections 164(f) and 1402(a)(12) of the internal revenue code.
Under section 1402(a)(12), a self-employed person may deduct 7.65% when computing net earnings from self-employment subject to SECA. This deduction reflects that an employee does not pay FICA tax on the employer’s portion of FICA tax for wages paid to an employee.
Additionally, under section 164(f), self-employed persons can deduct one-half of the SECA tax when computing income subject to income taxes. This deduction reflects that an employee does not pay income tax on the value of the employer’s portion of FICA tax for wages paid to an employee.
Whether the life expectancy rule or the five-year rule applies in a particular situation is governed by section 1.401(a)(9)-3, Q&A 4, of the treasury regulations.
The regulations provide that if there is a designated beneficiary, distributions are to be made in accordance with the life expectancy rule, unless the terms of the plan either (a) require that distributions be made under the five-year rule, or (b) permit the beneficiary to elect to use the five-year rule.
If the plan permits such elections by the beneficiary, the life expectancy rule will apply unless the beneficiary makes such election within a specific time period, or the plan provides that distributions will be made under the five-year rule if no such election is made.
The determination of which distribution period applies is made in accordance with these rules, and is not based on whether distributions in fact begin timely under the applicable rule.
Note: Section 4974 of the code imposes a 50% excise tax on any amounts that were required to be distributed under section 401(a)(9) but were not timely distributed, unless the imposition of such tax is waived.